A number of important measures have been taken to ensure that this ambitious goal is met. The constitution has been amended to allow for international arbitration between the Turkish State and foreign investors. A streamlining of the regulations governing operations in the energy and telecommunications sectors is expected to attract privatization, and Parliament is even now considering the necessary enabling legislation, which will be enacted very soon. These actions in the fiscal, privatization and structural reform areas are a part of the front-loading mentioned above, and the authorities have already taken most of the measures. Now let me turn to the program’s nominal strategies, most of which are the responsibility of the Central Bank. In an economy like Turkey’s, where inflation has a long history, expectations and inertia play important roles in the inflationary dynamics. This represents a major problem for the program, which needs to be addressed thoroughly. Since exchange rates have high public visibility, there was a broad consensus in Turkey that using the exchange rate as a nominal anchor would be an effective tool for interrupting the public’s inflationary expectations based on the past. In addition, the openness of the Turkish economy to capital movements makes the commitment to an exchange rate anchor particularly effective in affecting nominal interest rates. Accordingly, the exchange rate regime has been designed to provide clear signals as a basis for price and interest rate expectations, while avoiding the medium-term drawbacks experienced in the medium term by some of the other countries pursuing exchange rate based stabilization.

Fourth, on asset bubbles and the linked exchange rate system: the monetary policy objective of Hong Kong is exchange rate stability, rather than to target asset prices or inflation. Asset bubbles are not unique to economies with fixed exchange rates. Economies with floating exchange rates experience similar problems. In any case, it is difficult to tell ex ante whether there is an asset bubble. On the other hand, most research studies find that monetary policy is too imprecise and blunt to be used as a tool for targeting asset prices. Fifth, on the Hong Kong dollar being undervalued: there is no evidence. Recent empirical research by the HKMA and the IMF show that there is no evidence of currency misalignment for the Hong Kong dollar at present. Given the flexible and adaptive nature of the Hong Kong economy, wages, prices and other economic variables would adjust so that any misalignment in the real effective exchange rate would be corrected. Even a flexible exchange rate is not immune to sustained currency misalignment. Exchange rate  BIS Review 139/2007  5  movements are affected not only by economic fundamentals but also by market dynamics. A flexible exchange rate is arguably more prone to currency misalignment, particularly for small and open economies which are more vulnerable to changes in capital flows. Sixth, on widening the exchange rate band: the simple answer is no. It would only serve to undermine the credibility of the linked exchange rate system and invite speculation on the likelihood of further band-widening.