I will first refer to some stylized facts and factors behind the recent surge in capital inflows, and then on the policy challenges. Monetary policy in the developed world has had to take on the burden of cyclical stimulus. Hence, policy interest rates in the main high-income economic zones have been kept low for longer than expected at the end of last year, and several central banks have actually reinforced traditional monetary policy with further unconventional measures. The discussion about exit strategies has morphed into further balance-sheet stimulus, and markets are pricing-in that monetary accommodation will continue well into 2011. In contrast to the situation in the largest developed economies, emerging markets and some financially-stable developed countries have transited to a quick recovery phase, which in some cases is leading to above-trend growth and the fast closure of output slack. Macroeconomic policy has responded accordingly, first through the normalization of extraordinary liquidity and financial stability measures, then by moderating their fiscal and monetary impulses. Interest rates in emerging economies have, therefore, started to increase and are, according to most expectations, slated to continue increasing over the course of the next few years. These monetary policy trends have naturally led to discussions regarding their implications for capital flows, current accounts, economic growth, and real exchange rates. In particular, some concerns have been voiced about the risk of returning to a situation much like the one observed in the mid 2000s, when low interest rates in the developed world boosted capital flows into emerging economies.

4  The existing evidence for the case of Chile shows no significant effects on inflows or the real exchange rate, and limited effects on composition of inflows (Cowan and De Gregorio, 2007). See Ostry et al. (2010) for further discussion on capital controls and conditions for them to be used. 4  BIS Review 124/2010  An important aspect of this regulation is whether it should be adjusted according to the availability of capital inflows, or whether it should be time invariant. Let me share some thoughts with you on this issue. First of all, macro-prudential regulation should aim at reducing a risk build-up that could lead to episodes of systemic financial instability. It is not a counter-cyclical macroeconomic tool. Interest rate policy should be the main counter-cyclical tool for central banks. This being said, regulation should not introduce additional procyclicality into the financial system. In Chile, for example, provisions are done on the basis of expected losses during the life of the credit. This stops short of the Spanish dynamic provisioning rule, but reduces the procyclical impact of regulation, in particular compared to the method of constituting provisions according to actual losses. Second, although desirable in several aspects, it seems to me that financial stability (and the build-up of risks) is such a multidimensional concept that either hinders the possibility of rules based macro-prudential policy or limits it to certain aspects (for example, dynamic provisions), which must be supplemented with additional discretionary measures.