(IFF, 2012) (Ghosh et al, 2012). On the other hand, as market participants generally try to minimize the impact of regulation and its associated costs, the interconnection of regulated banks and these institutions highlighted the narrowness of previously defined microprudential rules.

With the benefit of hindsight, it has become clear that “inflation and output do not typically display unusual behavior ahead of asset price busts” (IMF, 2009, p.93). In other words, well behaved inflation and output performance provide few if any assurances that asset prices will not acquire a life of their own, with potentially high costs in terms of output foregone during the moments of bust. Besides noting the typical economic costs associated with asset price busts, IMF (2009) detects and points out some leading indicators of busts, namely, rapidly expanding credit, deteriorating current account balances, and large shifts into residential investment.

Therefore, the framework of flexible inflation targeting regime and micro-prudential regulation is not necessarily sufficient to avoid asset price booms and busts because of _macrofinancial risks_ that may develop beyond the scope of the framework. Given the high costs associated with asset price busts – including the possibility of protracted negative feedback loops between unsound private balance sheets, public sector imbalances and/or foregone employments and GDP – the negligence must be addressed.

_1.3 Cross-border Spillovers from Asset Price Booms and Busts and Large-Country Policy Responses as a Missing Dimension_ The neglect of asset price booms and busts by the received wisdom regarding inflation targeting and microprudential regulation acquires an additional dimension in the case of capital-receiving countries – like most emerging markets. Even if these countries succeed in avoiding domestic generation of _macrofinancial risks_ , they may experience asset price booms and busts caused by net capital-flow ebbs and tides derived from asset price cycles abroad. As those countries are incorporated into the network of inter-linked balance sheets of international financial institutions, they are vulnerable to spillovers and externalities, including contagion in terms of confidence, as risks pro-cyclically taken in large countries end up affecting the entire global system. By the same token, policy responses taken at the countries where asset price booms and busts unfold affect capital-receiving countries.

The framework of flexible inflation targeting and microprudential regulation does not address crossborder spillovers of asset price booms and busts and policy responses, although these are often of firstorder relevance. The neglect of asset price booms and busts, in particular, has a counterpart in the neglect of cross-border capital flows and macroeconomic policy spillovers. Both types of overflows and spillovers bring implications in terms of higher volatility of activity on the real side, more complicated monetary policy management, and augmented financial-sector risks (CIEPR, 2011).

Positive or negative feedback loops between domestic balance sheets and liquidity in other countries may outweigh by far the mitigating effects coming from exchange rate fluctuations in such situations. Furthermore, flexible exchange rates lose their ability to smooth balance-of-payments adjustments under 10