However, an expansionary monetary policy could not explain by itself the severity of the financial collapse the world is seeing today. There are countries where the monetary policy was expansionary, with interest rates at their minimum, and no housing bubble occurred. A couple of examples are Canada and Chile, two inflation targeters where, consistently with this policy framework, interest rates hit very low levels not so different from the Fed Funds rate (Figure 3). Still, housing prices generally did not experience increases comparable with those of other economies, and their financial systems have remained sound. Furthermore, in some cases housing prices did go up high, with clear signals of a bubble being formed. However, their financial systems made it through and remained stable and, despite the current difficulties including very recessive episodes, have avoided acute financial crisis. This is the case with, for example, Australia and Spain. Naturally, when facing disproportionate increases in the price of housing, both the level of borrowing and the building boom associated with it are symptoms that the downturn that comes with the cycle will be severe. This is because of the deleveraging that households will have to undertake and the contraction of the building activity. Still, this need not result in a systemic financial crisis. In any case, monetary policy can and does help in the creation of bubbles, although not so much by the level of the interest rate but by the monetary policy strategy with which financial turmoil is dealt with.

I am not saying that attention must not be paid to the exchange rate beyond its effects on inflation. Excessive deviation from its long-term fundamentals may create problems in terms of resource allocation and the business cycle. The exchange rate should be influenced through accumulating or reducing reserves. Some conditions must be met, however, in order for this to be effective and convenient. In the first place, it must be consistent with the inflation target, in order for the intervention not to threaten the credibility of the monetary policy. Secondly, to safeguard monetary policy independence, once the intervention is announced it must be implemented mechanically. All this shields the conduct of monetary policy, typically carried out in regular pre-established meetings, from the extraordinary decision of buying or not buying foreign currency. In particular, the sterilization of intervention decisions permits to preserve both the credibility and the independent management of monetary policy. Finally, and because of this sterilization requisite, the cost of intervention must be properly considered, because it entails a quasi-fiscal component that could be significant. In any case, to the extent that the decision to intervene is taken because of evident real exchange rate misalignments, the risk of suffering quasi-fiscal costs should be limited. Intervention would occur within the context of an extraordinary episode where the central bank would estimate that there are sufficient elements to evaluate that the current exchange rate dynamics are unsustainable and the market is not properly internalizing the long-term prospects of the real exchange rate.