In our last Monetary Policy Report we stated that, in our baseline scenario, we needed to grow somewhat less than our potential to contain the inflationary pressures and ensure inflation convergence to its target rate of 3% annually over a two-year horizon. We also thought that the world economy would not help to reduce inflation. Today the scene has changed and we are carefully reviewing its inflationary implications. To begin with, the international scenario may trigger a reduction in demand that could help contain inflation. This certainly has implications on the monetary policy trajectory, consistent with the inflation target. Secondly, commodity prices are in a tailspin, particularly in the case of oil. However, these events have not fully passed through to our economy, because our currency has depreciated substantially. Overall, more evidence is needed with respect to the persistence of the recent events in the world to calibrate the monetary impulse. The Central Bank of Chile has paid close attention to external developments and has been ready to provide any liquidity required for the proper operation of the financial markets, as it has been doing since the end of September and will continue to do for as long as it deems necessary. I am convinced that we will weather this international financial crisis successfully. We have built a macroeconomic policy scheme with sufficient degrees of flexibility and a strong commitment to stability that, under the current circumstances have the challenge of attenuating the adverse world economic scenario and ensure stability.

As a matter of fact, whenever accelerated growth in credit and money aggregates occurs simultaneously with soaring asset prices and loose lending standards, increased inflation becomes very likely over the three years that follow (Roffia and Zaghini, 2007). 8 In this context, one can argue that an increase in lending with inflation prospects can be fought with a tightening of monetary policy. However, if the boom was triggered by lack of regulation or supervision, monetary policy tightening by itself could probably be ineffective – or even counterproductive – if the financial system is weakened because of excessive risk taking. Thus, financial regulation plays a major role in granting financial integrity. At the beginning, regulation focused on the strength of individual institutions. However, the tensions we are seeing now exemplify, once again, how individual fragility may quickly evolve into systemic problems. The interrelationships among financial institutions and the proper operation of the markets where liquidity is traded are essential ingredients of a market economy, but these characteristics are also the channels of financial contagion, as recently seen. So it is crucial to have a systemic vision, not only from the perspective of how the different institutions relate to each other, but also how the different types of financial and operating risks are intertwined, creating potential vulnerabilities. The Financial Stability Reports that many central banks put together periodically – including us – seek to evaluate the resiliency of the system as a whole to large disruptions, by carrying out stress tests.