While the Asian regional economies have common threads that prevail across the region, the economies are generally diverse in their economic activities. While there are areas of competition, there are trends towards increasing specialisation and complementarities. These structural shifts arose from new technologies, new demand patterns and new production organisation structures. In essence, there is a movement from bilateral inter-regional trade flows to a more fully developed intraregional division of labour incorporating all phases of production and markets. This has led to greater optimising of the comparative advantage of the region. Finally, there has been an intensification of regional co-operation in the aftermath of the Asian financial crisis. There has been a high level of financial co-operation among the Asian economies. Co-operation has been in the area of enhanced regional surveillance, standardisation of systems and documentation, regional capacity building programmes and regional swap facilities. This strengthened co-operation enhances the foundations for realising the potential that the region possesses. Ladies and gentlemen, In a world where uncertainty has become a permanent feature of the environment, the challenge before us is to be able to increase our tolerance level to the shocks and changes that may occur. Building tolerance levels involves enhancing our capacity, strength and resilience to cope with the changed environment. Precautionary measures can be taken to reduce the risks and vulnerabilities. Despite uncertainties and unstable conditions, initiatives can be taken to achieve sustainable performance.

This is because experience has shown that it is difficult for small economies to pursue independent monetary policy if interest rates are their only policy instrument, their currencies float freely, there are no restrictions in residents’ unhedged foreign exchange risk, and financial integration with the rest of the world disconnects the transmission of monetary policy through the interest rate channel. I would like to pause here, as this last item is of particular importance for Iceland at present. I conducted a study of this topic during my tenure with the Bank for International Settlements in 2004–2009.1 I delved into it again last summer, as can be seen in the speech I gave in Singapore last August, which can be found on the websites of the Bank for International Settlements and the Central Bank, and in my forthcoming paper, to be published in the  1  4  “Financial globalisation: key trends and implications for the transmissions mechanism of monetary policy”. BIS Papers No. 39, April 2008. http://www.bis.org/publ/bppdf/bispap39c.pdf  BIS central bankers’ speeches  Singapore Economic Review. These writings contain more detailed explanations, but if we consider the main points and allow the tendencies entailed in financial integration to develop to their limit, the outcome is abundantly clear. The interest rate channel of monetary policy becomes utterly clogged up in small, open, and financially integrated economies where longerterm interest rates are determined by rates in large economies. Monetary policy transmission shifts entirely to the exchange rate channel.