This increase in the balance sheets of central banks (reserves) has been pointed out as a source of inconsistency with future price stability. Increasing interest rates to secure price stability in the future will require undoing those operations, which could threaten financial stability. But central banks that are facing this challenge have an instrument that may be very useful in this situation: they have the ability to pay an interest rate on those reserves different from the monetary policy rate. This additional instrument should be enough to secure a smooth exit from their current situation without affecting price stability (see Cúrdia and Woodford, 2010). Again, price stability and ex-post financial stability are mutually consistent. Nevertheless, some analysts have argued that if some unconventional policy interventions have been too extended, price and financial stability may not be consistent from an intertemporal perspective. In effect, some dimensions of unconventional monetary policy, in particular credit policy, involve a fiscal dimension. It has been argued that those fiscal aspects are likely to threaten monetary policy independence and therefore jeopardize price stability (Goodfriend, 2010). Although these concerns are relevant, I think that the key solution to them will be strengthening independence of central banks and generating a more resilient financial system as discussed before. Let me close by addressing the conditionality statement that I made regarding dealing with financial shocks and price stability a while back. In the past, some emerging market economies were incapable of implementing countercyclical monetary policy.

One instrument (namely, the interest rate) is often not enough for pursuing two objectives. More generally, the two objectives should be addressed with more than one instrument. The choice of instrument will depend on both the cause of the financial fragility and the institutional setting of each country. For a start, central banks should work closely with “micro-prudential” supervisors, communicating potential risks so that these can be incorporated into the supervision process or into changes in regulation. A regional house bubble would be a good example of this kind of coordination, with supervisors adjusting provisions accordingly. In addition, central banks  4  Chapter V, Financial Stability Report 1st half 2009, Central Bank of Chile. http://www.bcentral.cl/publicaciones/politicas/pdf/ief2009_1.pdf  BIS Review 76/2010  5  should consider macro-prudential regulation that adjusts capital, liquidity or asset quality regulation through the cycle or in periods of higher risk taking. Finally, central banks should not discard using their balance sheet to “correct” the prices of financial assets when these asset prices are leading to increased vulnerabilities in the financial system. In EMEs this is typically the case of a boom where there are signs that the currency may be strengthening beyond its fundamentals, in which case a mechanism of selfinsurance, such as accumulation of reserves, may help to smooth the transition and to have the economy well-prepared for potential reversals of capital flows. In the case of Chile, we have intervened three times in the exchange rate market since the currency was allowed to float in 1999.