position, claiming that any inflation - targeting central bank should react to asset price misalignments beyond their implications on expected inflation over the policy horizon. in my view, there are three reasons why monetary policy, in general, should not react to asset prices beyond their impact on projected inflation : • first, it is not clear that an increase in interest rates will be capable of stopping an increase in asset prices. the required adjustments might be so large that they could end up unnecessarily generating high unemployment and an undesired drop in inflation. • second, what matters here is to safeguard the stability of the financial system. an excessive interest rate aiming at controlling asset prices could even trigger financial instability, which is precisely what it is meant to avoid, especially if the increase in asset prices is accompanied by higher financial fragility. • finally, under inflation targeting, any interest rate movements that are inconsistent with inflation converging to the target may undermine the credibility of monetary policy, destabilizing inflationary expectations, and weakening the effectiveness of monetary policy. this is particularly important in the case of emerging economies with a shorter record of monetary stability. another reason that has been put forward to not try to affect asset prices through monetary policy is simply that it is impossible to determine when prices are significantly misaligned with their fundamentals. although i agree with the fact, i do not think this is a strong reason. indeed, even though it is difficult to determine when prices are fundamentally misaligned, policymakers should worry about this phenomenon. however, acting through monetary policy may not be the best option, and it is better to look more closely at financial regulation and how to limit the procyclicality of the banking system and build enough cushions for the downturn. this should also reduce fragilities that are generated during the upturn. 3. inflation targets, exchange rates and intervention an inflation - targeting regime, where the policy instrument is the interest rate, must operate within a context of a flexible exchange rate. this solves efficiently and unambiguously the well - known impossible trinity for countries financially open, and allows the control of interest rates at a level consistent with the inflationary objective. adding an exchange rate objective weakens the capacity to control the interest rate, affecting the ability to meet the inflation target. however, the exchange rate generally has effects on monetary policy, since persistent movements of it do affect inflation. in this case, the natural result is a leaning

in us $ ) lme copper price ( us $ cent / lb ) wti oil price ( us $ / barrel ) brent oil price ( us $ / barrel ) 10. 1 terms of trade 0. 5 - 7. 4 2. 2 - 0. 4 2. 7 7. 8 5. 8 3. 5 3. 0 2. 3 - 0. 5 1. 6 7. 7 5. 6 3. 5 2. 8 2. 0 1. 9 0. 3 - 0. 3 1. 3 0. 5 8. 1 8. 0 7. 1 6. 6 4. 5 4. 3 3. 4 3. 3 ( levels ) 2. 4 1. 7 1. 4 8. 3 7. 3 4. 8 3. 9 2. 3 1. 2 0. 9 8. 2 6. 4 4. 7 3. 7 ( annual change, percentage ) - 5. 0 - 2. 6 - 0. 8 1. 3 1. 3 ( f ) forecast. sources : central bank of chile based on a sample of investment banks, consensus forecasts, the imf and statistics bureaus of respective countries. bis central bankers ’ speeches figure 3 real exchange rate ( * ) ( index, 1986 = 100 ) rer 1997 - 2011 average 1992 - 2011 average ( * ) december figure includes information up to 13 december 2012. source : central bank of chile. figure 4 cpiefe inflation ( annual change, percentage ) - 2 - 2 - 2 - 2 - 4 - 4 - 4 - 4 cpi inflation ( 1 ) ( annual change, percentage ) 07 08 09 10 11 12 13 14 07 08 09 10 11 12 13 14 mp report sep. 2012 mp report dec. 2012 ( 1 ) december 2012 figure uses median of monthly inflation forecast in the ees. ( 2 ) gray area, as from the fourth quarter of 2012, shows forecast. sources : central bank of chile and national statistics institute ( ine ). bis central bankers ’ speeches figure 5 mpr and expectations ( percentage ) fbs first half december 2012 ees december 2012 mpr source : central bank of chile. table 3 growth in housing prices ( real annual growth, percentage ) 2002 - 2007 2009 - 2t2012 nation - wide total 3. 1 5. 7 average of districts with significant increases 1. 6 8. 3 ( 1 ) averaged y - o - y growth between first quarter of initial year and last quarter of final year in