Compared with the anomalous situation at present, in which these flows are from the latter countries to the former ones, owing to the combined impact of the absorption exerted by the US economy and the exchange-rate policies in Asia, a smoother working of the world economy should channel surplus saving from the more mature economies to those where the return on capital is higher, as they are at a more incipient phase of development. It should be recalled that many of the achievements of the world economy in recent years, such as moving on to a high, inflation-free growth path and infusing the emerging areas with greater dynamism so as to allow them to achieve standards of living closer to those of the richer countries, are a direct or  2  BIS Review 45/2005  indirect consequence of growing worldwide integration. Globalisation has thus given most countries more fluid access to foreign markets while offering them incentives to concentrate on those industries in which their comparative advantage lies, and it has provided consumers with a wider range of products at more favourable prices. But it should not be forgotten that the rigidity of certain countries’ exchange-rate policies has ultimately triggered protectionist threats in others that see themselves as adversely affected. It is thus vital not to succumb to these protectionist temptations and to persevere with the liberalisation of international trade so that the trends which have allowed the world economy to achieve its recent favourable results may become entrenched.

For emerging economies, capital flow volatility is a fact of life and something that policy makers have to deal with; and we have to acknowledge that the size and volatility of capital flows will only intensify. While the transmission of global shocks to the domestic economy through the real economy channel – that is through trade and investment – is something that we have been dealing with for decades, policy makers today are confronted with the increasingly dominant channel of 1/3  BIS central bankers' speeches  transmission of shocks through the financial markets, at least in the immediate term. All of us have experienced how spillovers from external developments that were manifested through capital flow volatility have adversely affected domestic financial markets, asset prices, liquidity conditions and importantly, exchange rates. All these challenges make for a complicated policy environment for ASEAN central banks. Gone are the days when keeping our own house in order is enough. Sure, good fundamentals matter as they have no substitute. They are, however, no longer sufficient. As Keynes rightly pointed out a long time ago, “the market can stay irrational longer than you can remain solvent.” Often, we have seen how external developments that are beyond our control, such as the unprecedented quantitative easing by the advanced economies and the subsequent Taper Tantrum, triggered periods of large inflows followed by sharp reversals in emerging economies with severe consequences. For small open economies, these flows can easily overwhelm the domestic financial markets and lead to build-up of vulnerabilities in the economy.