well in reducing inflation, but at the cost of loss of international competitiveness, leaving a legacy which had to be addressed by other painful remedies. it is worth noting, also, that even hard fixes are subject to attack : it just takes a different form - a run on domestic banks which drives up interest rates. quoted by cooper ( 1999, p 9 ). • nominal exchange rates are, unaccountably, closely correlated with real exchange rates ; 6 • the switch from fixed to floating rates has produced much more variability ( “ an order of magnitude more ” ), even when fundamentals are not more variable ( flood and rose 1999 ) ; • fundamentals cannot explain the behaviour of the exchange rate over a short / medium - term horizon ; 7 • exchange rates have at times exhibited long - lived swings, with no apparent changes in fundamentals significant enough to justify them. the us dollar appreciated by about 90 % against the deutsche mark in the first half of the 1980s, only to completely unwind this appreciation by 1988. the yen appreciated by about 75 % against the us dollar in the first half of the 1990s, and unwound this appreciation by 1998. as a result of this experience, a textbook free float with interest rates set exclusively for the needs of the domestic economy ( ie “ benign neglect ” ) is out of favour. the exchange rate is routinely a factor in setting interest rates. many countries intervene ( if only occasionally ) in foreign exchange markets, and when this is done with finesse and sensibly ( ie not to defend a particular exchange rate ), it has often been helpful. 8 the intrinsic problems of exchange rates in emerging countries if all this produces volatility and misalignment in developed countries ’ exchange rates, how much more serious is it for emerging countries which have : • much less well - defined trade - based fundamentals ; • no long historical experience of market - determined exchange rates ; • rapidly evolving production structures ; • few friedmanite stabilising speculators ; • much larger and more volatile capital flows, in relation to the size of their domestic capital markets and economies more generally. on top of this, we have the evidence from hausmann et al ( 1999 ) that those latin american countries which embraced floating during the 1990s experienced substantially larger changes in interest rates see cooper ( 1999, p 16 ). the classic reference, meese and rogoff ( 1983 ), showed that existing exchange rate models based on economic

this stage, but they underscore the need for sound lending practices and for appropriate prudence by investors. graph 5 click to view larger concluding comments i want to conclude with a few comments about the financial stability role of the reserve bank 2. the bank has a longstanding mandate for financial stability, affirmed for example as part of the wallis reforms in 1998. in the post - wallis world, this has not been primarily a regulatory function. the bank does have regulatory powers in some areas relating to financial stability, notably in its oversight of payments systems and financial market infrastructures. but the financial stability function goes well beyond that to the reserve bank ’ s wider role in the financial system. it includes the bank ’ s role as liquidity manager for the system and as the provider and operator of core payments infrastructure. it also includes coordination with other regulators. at a formal level, this is done through the bank ’ s role in chairing the council of financial regulators, but there are numerous less formal channels for coordination and for sharing information and analysis. these arrangements were reviewed and supported most recently in the murray inquiry. one important component of our financial stability work is the provision of timely risk analysis, to help inform the policy debate and also to help inform the decisions of lenders and investors. i have given a summary of our most recent analysis today, and i hope you will find that helpful in informing your own investment decisions. with that, i thank you for your attention, and hope you have a successful conference. for a fuller discussion of this topic, see my earlier speech “ the financial stability role of central banks ” may 2013. bis central bankers ’ speeches