technology and financial innovation, and strong arguments were being made to the effect that open capital accounts would bring significant benefits. after all, ongoing real economic integration at a global level demanded at least some degree of global financial integration. in turn, freer capital movements, the ongoing cross - border financial integration, and the growth of private capital flows that followed undermined pegged exchange rates and thus contributed to the spread of flexible exchange rate regimes and inflation targeting in many parts of the world, but in the european union this development provided part of the rationale for a monetary union. the current international monetary system and the official part of the global financial safety net largely reflect the contours of the global economy as they were before global financial integration and private capital flows reached the level we have seen in this century. back then, the global macroeconomic problem was related to global current account imbalances and asymmetric adjustment. keeping your own house in order was in most cases both necessary and sufficient for maintaining economic stability in individual countries. imf facilities to lend to sovereigns of debtor countries facing balance of payments difficulties were the most important part of the global financial safety net ( gfsn ). the world we currently live in is different. financial imbalances in both net and gross balance sheets can be more important than current account imbalances and certainly were so in the build - up to the great financial crisis ( gfc ). this is a world of cross - border spillovers and spillbacks. it is a world where, for small and open economies ( soes ), keeping your own house in order is certainly necessary but no longer sufficient, at least not if we restrict ourselves to traditional demand management and prudential instruments. financially integrated small and open economies can still be overwhelmed by large and volatile capital flows driven by push factors. it is a world that needs additions to the gfsn, some of which we partly have – such as fx liquidity provisions to internationally active banks through central bank - swaps – but some of which we do not have. the international community is certainly aware of these issues. the imf has done good analytical work in this area and proposed reforms. work has been done under the auspices of the g20 looking at potential reforms to the international monetary sytem ( ims ), and currently the eminent persons group is working on a report to the g20 to be delivered at this year ’ s autumn meetings of the imf. but progress in

, gives rise to two concerns : first, regarding detrimental effects on the traded goods sector, and second, on financial stability where volatile capital flows, currency mismatches, and rollover risk of foreign currency debt are among the key players. adverse effects on financial stability can be particularly severe when a blocked interest rate channel and an erratic exchange rate channel interact badly with other economic and financial risks that can face small, open, and financially integrated economies – such as the global financial cycle, domestic financial vulnerabilities, and policy conflicts. we saw trends before the gfc that were consistent with this story. data on longterm interest rates and spreads in small advanced economies and in many emerging markets economies showed strong and growing correlations with longterm rates and spreads among core rate setters ( mainly the us and the eurozone ), although still some way from the theoretical limiting case. the gfc reversed this process somewhat, as risk premia skyrocketed, cross - border banking partly retreated to home base, and restrictions on capital movements were in some cases reintroduced. it has come back to a significant degree. before the crisis, some argued that these patterns could be due to common shocks, convergence of monetary policy frameworks, and increased credibility of those frameworks. however, case studies, comparisons of the pre - and post - crisis periods, and other observations make it more and more plausible that global financial integration is the main driver. the bottom line is that it is becoming more difficult to conduct independent monetary policy in small, open, and financially integrated economies, and although a flexible exchange rate is a necessary condition for doing so, it might not be sufficient, especially when we factor in the financial stability aspects. this, i think, is why we find on occasion that we are closer to facing a dilemma than a trilemma. i think it is still a trilemma, but with trade - offs of variable severity. 2 what can individual countries do about this? first, those that have the option can enter a monetary union. that has its own pros and cons, as you all know very well. but for a soe were the mu constitutes the biggest trading partner, issues of excess exchange rate volatility and domestic currency mismatches become much less pronounced. second, they can give up on independent monetary policy while maintaining their own currency by either pegging the exchange rate or pegging interest rates to those of global rate setters. the problem with the