And I recognise the theoretical attraction of having an additional degree of freedom in economic adjustment. In practice, however, there must be doubt about whether, in view of the possibility of severe exchange rate volatility and overshooting, this is a luxury that all economies can afford. There is also the question of whether the relationship between the current account balance and the exchange rate is always the same across different economies so that exchange rate adjustments are a panacea for correcting external imbalances. Regrettably these questions are simply not asked, or, if asked, they are drowned by political noises that appear to be made on the basis of narrow, political concern over bilateral, rather than multilateral, trade imbalances. In any case, flexible exchange rates for many currencies in Asia does not necessarily mean exchange rates determined freely by the market, as proponents would have it. As it turns out, more flexible exchange rates in Asia have meant exchange rates being determined in a flexible manner by the authorities, through intervention, controls and restrictions, at levels that are considered in their best interests. And their best interests, whatever they are, seem for the time being to be manifested in the substantial accumulation of foreign reserves. Perhaps reserve accumulation is the objective. And I can understand why, if this is the case. The comfort of substantial ammunition for coping with the recurrence of financial turmoil has become essential for emerging markets in Asia.

The National Bank incurs risks on its investments that cannot be hedged based on monetary policy concerns. Losses from gold and foreign currencies in particular can be significant. An adequate volume of reserves allows the National Bank to bear these risks, especially since such fluctuating values tend to correct themselves over the long term. Greater diversification of both the currencies and the investment instruments can bring about the necessary growth of monetary reserves. Diversification effects permit investments in higher-yielding and - from an individual perspective - riskier investments such as equities and corporate bonds without substantially increasing the overall risk. The return potential of monetary reserves depends on the liquidity and security requirements of the investments in terms of monetary policy considerations. Pursuing an efficient investment policy for the National Bank means achieving a return potential that is as high as possible within the existing restrictions. Under the new Act, the National Bank will pursue a broader diversification of its investments and, in particular, also invest in equities and corporate bonds. Because of the National Bank’s special position as a central bank, the exposure to equities and corporate bonds is subject to some specific considerations: first, a conflict of interest may arise  BIS Review 39/2004  1  between monetary policy and investment policy. For instance, interest rate hikes by the National Bank can have a negative impact on a company’s profits. Second, owing to its responsibilities in the area of system stability, the National Bank has insider information in the financial sector.