christian noyer : is inflation set for a comeback? speech by mr christian noyer, governor of the bank of france, at deutsche bank, paris, 19 march 2008. * * * with inflation surging everywhere, it is quite natural to wonder if we could have reached the end of this worldwide era of “ great moderation ” in both output and price volatility which has characterized alan greenspan ’ s tenure of office. true, one could argue that we are just experiencing one - off shocks in commodity and food prices whose inflationary consequences will wane rapidly thanks to the increased flexibility of our economies. but other possible scenarios are more worrying. second - round effects could, after years of relatively well contained wages, be triggered by shifts in inflation expectations ; through the catching - up of developing economy, the globalisation process could have become inflationary ; the ageing of our developed european economy, the necessary fight against global warming could structurally add inflationary pressures,.... and the room for monetary policy decisions could be restricted by the state of the financial and banking system and by the risks of slowdown of growth. i would like to review these issues. in order to avoid any misunderstanding let me immediately make my point. even if it is clear that inflationary pressures have both increased and changed in their nature, i firmly believe that monetary policy can still ensure price stability, over the medium term. my central scenario for the short term is a scenario where after a couple of months inflation will recede in the euro area and come back “ below but close to 2 % ” in accordance with our definition of price stability. it is not unusual to witness commodity and consumer prices acceleration in the initial phase of an economic slowdown, as there is some inertia in employment and commodity prices dynamics with respect to activity. this has happened previously at the end of the 1990s, with a subsequent moderation in inflation. in the short run, recent inflationary shocks are likely to maintain inflation at a high level for most of 2008 as we may expect a significant degree of persistence in energy, industrial commodity or some food price increases ( such as meat ). in the euro area, hicp inflation has reached 3. 3 % in february. it might remain well above 2 % in the coming months but ebbs later this year according to ecb staff forecasts. these projections rely on a scenario of global economic slowdown and moderation in commodity prices, which would contain pressures on capacity utilis

including other banks. given reduced confidence in their ability to quantify and price risks, balance sheet capital remained a scarce commodity. as a result, both overnight and term interbank - funding markets were pressured considerably. even today, some banks face potentially large needs for dollar funding, and their efforts to manage their liquidity may be contributing to pressures in global money markets and foreign exchange swap markets. more broadly, many financial institutions appear hesitant to put opportunistic capital to work. the next phase – revaluation – requires that the new prices be established in accordance with the new financial environment. the process of price discovery appears to be quicker and more assured among corporate credits. think, for example, of the markets for high - yield and leveraged loans, in which risk spreads have returned to more moderate levels. we have seen significant evidence that the process of revaluation in other previously disrupted markets is also under way. investors are differentiating risks, for example, among assetbacked commercial paper programs, and many spreads have moderated. revaluation, however, may be a slower, tougher slog in the mortgage markets for those vintages in which the underlying asset quality is less certain. how quickly asset markets substantially complete the revaluation phase depends on the speed with which stakeholders regain comfort in their ability to value these assets. financial markets rarely normalize in a steady, linear fashion. more often, as market sentiments sway between fear and greed, asset prices fluctuate and seek support ( volume ) before establishing new trading ranges. that pattern is particularly pronounced when the underlying economic fundamentals are less certain. hence, the next phases – review and refinement – are the hardest to predict with precision. as circumstances dictate, some financial institutions will review and refine their capital ratios, risk metrics, and business imperatives and proceed forward. others may find that, in the course of review, they return to the phases of retrenchment and reliquification. central bankers are prudent to stay alert to these changes. without a doubt, then, this is a time of testing. stakeholders will need to discern whether they are witnessing some impairment of the financial sector, or merely a realignment of the competitive landscape. moreover, i suspect that some of the more complex structured products and investment strategies will be substantially modified ; others will die. but, in the end, an improved understanding of how to create, bundle, distribute, and assess