We also need a regulatory framework that ensures financial stability, a feature that countries like Chile and Colombia have succeeded in preserving in the actual juncture. The causes of the crisis: was it monetary policy or was it financial fragility? The argument attributing a leading role in the current crisis to monetary policy claims that low interest rates combined with large current account surpluses in emerging economies, particularly Asian and oil-exporting ones, created an abundance of liquidity that triggered excessive increases in asset prices (bubbles). This was particularly important in the value of real estate assets. When the bubble burst, the crisis erupted. Then, this argument claims that the housing bubble was caused by monetary policy, which failed to act opportunely and permitted severe imbalances to accumulate. Nonetheless, one must bear in mind that soaring asset prices do not necessarily end up in a crisis like this one. Closer attention must be paid to the financial fragility that accompanied this process, whose main culprit was the unrestrained financial innovation that generated deep distortions that neither markets nor regulators were able to predict. An expansionary monetary policy can undoubtedly induce an excessive increase in the prices of assets and credit. The role of monetary policy, in our case carried out through an inflation targeting regime, is to smooth the business cycle. Therefore, it is possible to think that a very expansionary monetary policy can exacerbate an economic boom. Likewise, such a policy will have serious consequences on output once the monetary impulse is withdrawn.

If the slightest exchange rate movement will prompt an intervention persistently, the market’s perception of this greater stability of the exchange rate may limit the power of monetary policy. For example, fighting an asset price bubble, by raising the interest rate while intervening at the same time to prevent a larger appreciation, may be counterproductive, because the incentives for carry trade positions may exacerbate the bubble and the exchange rate appreciation itself. 3  3  This may explain the results about exchange rate instability presented in Batini and Nelson (2000), when the exchange rate is subject to bubbles which are dealt with via the interest rate. BIS Review 68/2009  5  Final remarks Financial stability must be preserved with an adequate regulatory system. Agencies must analyze the strength of institutions, while central banks must evaluate the system’s overall stability. Regulators and central banks must closely cooperate and work in the effort of maintaining the integrity of the financial system. Regulating specific institutions is not enough, because interconnections exist that could derive in a systemic crisis. The current crisis proves that the regulatory scope must encompass every agent with a systemic importance. So a proper macro-prudential regulatory system is needed. This is a system still in debate, particularly regarding the instruments that must be applied to achieve this function. A first set of instruments has to do with capital adequacy. However, this is not enough, and it is no trivial to judge the soundness of the financial system by its capital and leverage levels.