the fx market. with more than 100meuros volume a day, continuous quoting and low spreads, the market has recently been able to absorb larger orders from both sides of the market than before, within only moderate exchange rate movements, and without an excessive central bank ’ s assistance. indeed, the interbank market volumes and the central bank ’ s presence have been inversely correlated, and this behavior is in line with the experience some other countries, for example the czech republic, had at this stage of market development in transition. in serbia, the daily fx volatility increased at the beginning of the year, following the discontinuation of nbs interventions in the final months of 2010. after calming down during the first months of 2011, the volatility started rising once more in may this year – again after the nbs stopped intervening. while the stronger nbs interventions would successfully calm the markets, they would also delay market development by stifling genuine market making of private banks. some of our evidence points out that the short - term exchange rate volatility increases gross trading volumes in the interbank market and thus strengthens the arbitraging behavior of market participants. chart 2. short - term fx volatility and spot trading volumes in the interbank market interbank market spot gross trading volume ( rhs ) st. dev. ( eur m ) 30 - days moving average ( lhs ) 0. 008 egarch ( lhs ) 0. 007 0. 006 0. 005 0. 004 0. 003 0. 002 0. 001 0. 000 jun jul avg sep oct nov dec jan feb mar apr may jun jul our recent experience thus gives a fairly straightforward answer to a notorious chicken - andegg problem. less central bank presence in the market increases short - term exchange rate volatility, which in turn strengthens market making and volumes, making the market more resilient to shocks and thus decreasing the need for nbs interventions. in addition to supporting market making, higher short - term volatility should also help market development by discouraging short - term speculative behavior. arguably, a 1 % daily volatility in the exchange rate presents a problem for an investor seeking an immediate profit from its fx position, but is less of an issue for a longer - term investor in treasury securities. in this manner, the higher short - term volatility may have also strengthened the stability of

bojan markovic : fx volatility and market stability speech by mr bojan markovic, vice governor of the national bank of serbia, at the annual aci conference, zlatibor, 17 september 2011. * * * ladies and gentlemen, a year ago, i was standing here in front of the very much the same audience, expounding on the benefits of exchange rate flexibility. i argued that exchange rate flexibility is a necessary backbone of stable and low inflation, and as such it must stay with us in the foreseeable future. i reasoned that movements in the exchange rate absorb shocks that otherwise would have gone to inflation or output and applauded the role the flexible exchange rate played in sheltering our economy from the impacts of the crisis. at the same time, however, i called for a greater use of hedging instruments and sheltering the financially less literate sectors of our society from unwarranted exchange rate exposure. the way forward, i argued, is not through limiting exchange rate volatility, but rather through expanding on the use of dinar based and hedging instruments. accordingly, monetary policy based on a flexible exchange rate has become a cornerstone of our efforts to increase the use of dinars in the economy. a year on, some of the effects of exchange rate volatility are already visible. the daily exchange rate has certainly become more volatile. according to some measures1, the daily volatility increased threefold in the past year, although it still remains lower compared to, for instance, volatility in similar countries with flexible exchange rate, such as poland, hungary or romania. and we expect that to remain the case in the period ahead. chart 1. nbs interventions and short - term fx volatility nbs interventions ( rhs ) st. dev. ( eur m ) 30 - days moving average ( lhs ) 0. 008 egarch ( lhs ) 0. 007 0. 006 0. 005 0. 004 0. 003 - 20 0. 002 - 40 0. 001 - 60 0. 000 - 80 jun jul avg sep oct nov dec jan feb mar apr may jun jul charts 1 and 2 report 30 - days moving average and egarch measures of daily volatility. bis central bankers ’ speeches the increase in exchange rate volatility was taking place against a declining presence of the national bank of serbia ( nbs ) in