network in many important respects, the current financial crisis is cut from familiar cloth. its genesis was the over - extension of credit, over - inflation of asset prices and over - exuberance of participants. from the south sea bubble to the sub - prime crisis, this roll - call of excesses is familiar. gerald corrigan, ex - president of the new york fed, said ahead of the crisis : “ in recent years the pace of change and innovation in financial markets and institutions here and around the world has increased enormously as have the speed, volume and value of financial transactions. the period has also seen a greatly heightened degree of aggressive competition in the financial sector. all of this is taking place in the context of a legal and a regulatory framework which is increasingly outdated and ill - equipped to meet the challenges of the day. this has led to … concern that the fragility of the system has increased, in part because the degree of operational, liquidity and credit interdependency has risen sharply ”. 2 corrigan was speaking in january 1987. the crisis foretold was the october 1987 stock market crash. plus ca change. yet in some more fundamental respects this time ’ s crisis feels different – larger probably, more discontinuous, complex and interconnected certainly. there are already numerous accounts of why that might be. here, i argue that these knife - edge dynamics can essentially be explained by two structural features of the financial network. these have developed over many years but at particular pace over the past decade. they are complexity on the one hand, and homogeneity on the other. in essence, the financial network has over time become progressively more complex and less diverse. why? and what have been the consequences? in the 1987 film wall street, the financial sector mantra was “ greed is good ”. the stock market crash of the same year put paid to that doctrine, at least temporarily. by the early part of this century, both the circumstances and the individuals had changed. so too had the mantra. it had become the rather gentler “ diversification is desirable ”. risk - taking became less gordon gekko and more merton miller. diversification came care of two complementary business strategies. the first was “ originate and distribute ”. risk became a commodity. as such it could be bundled, sliced, diced and then re - bundled for onward sale. credit became, in the jargon, structured. securitisation was one vehicle

quite unrelated to fundamentals. • – if you intervened, but did not sterilize the resultant liquidity, you become vulnerable to inflation pressures and asset price bubbles. – if you intervened in the forex market and sterilized the resultant liquidity, you may find interest rates firming up – which attracts even more flows – a classic case of dutch disease. – what all this says is that there is really no benign option for dealing with volatile capital flows. there is one other important issue relating to forex intervention. both currency appreciation and currency depreciation, quite unrelated to fundamentals, are bis central bankers ’ speeches complex problems. but there is a significant asymmetry between intervention for fighting appreciation and intervention for fighting depreciation. • when you are fighting currency appreciation, you are intervening in your own currency. your capacity to do so is, at least in theory, unlimited, quite simply because you can print your own currency. • but when you are fighting currency depreciation, you are intervening in a hard currency. your capacity to intervene is, therefore, limited by the size of your forex reserves. what complicates the dilemma is that the market is aware of this. • so, there is the real danger that by intervening in the forex market, you could end up losing forex reserves, and not gaining on the currency. the lower your reserves dip, the more vulnerable you become. and the vulnerability can become quite serious if your reserves go below the level markets perceive as necessary to regain market access. • it should also be clear that a failed defence of the exchange rate is worse than no defence. so, when you are intervening in the forex market, it is important to make sure that your intervention is successful. in that context, the questions on this topic of forex intervention are the following : ( i ) under what conditions is it appropriate for countries to intervene in the forex market? ( ii ) under what conditions is forex intervention preferable to capital controls? ( iii ) in most cases, countries claim that they are intervening in the forex market, not to target any particular rate, but only to manage the volatility in the exchange rate. is it necessary then to define upfront your measure of volatility that will trigger intervention? 2. reserves • the optimal level of reserves that countries may hold has been one of the important policy issues post - crisis. • an argument in support of countries holding size