evident with the increasing application of derivatives to credit risk. the rapid globalisation of finance is well illustrated by the phenomenal growth in cross - border financial activity. an april 1995 survey by the bank for international settlements estimated that an average of us $ 1. 2 trillion flowed through the world ’ s foreign exchange markets each day, up 45 % on three years earlier. estimated turnover of over - the - counter derivatives on an average day was us $ 880 billion, 70 % of which involved transactions with counterparties in different countries. an article in institutional investor in august 1997 provides another illustration of the magnitude of cross - border finance - - “ nearly us $ 150 billion of net new private capital poured into the main latin american and asian economies in 1996, almost double the 1995 level ”. these numbers are enormous however you want to look at them. new sources of systemic risk the globalisation of finance, the liberalisation of financial markets and rapid technological change have opened up new opportunities in commerce for achieving economies of scale, and facilitating the international rationalisation of production and distribution. the resulting benefits include productivity growth and improving living standards. innovations like derivatives improve the efficiency of financial markets. new technology allows sophisticated management information and control systems, and the application of complex analytical models to help institutions manage risks more effectively. but while considerable benefits flow from such developments, they also inevitably bring with them new risks. one of the most important from a central banker ’ s perspective is the introduction of new sources of risk to the stability of the financial system : • liberalisation and globalisation bring competition, which squeezes out the rents created by previously protected markets. this produces efficiency gains but it also means that financial institutions in the new environment have less of a buffer of protected profits and are therefore more vulnerable to distress caused by either mismanagement or misfortune. • derivatives bring new risks in that they can expose financial institutions to greater leverage, thereby allowing for shocks to be amplified. in addition, they increase the linkages between national financial markets, which means that adverse events are quickly transmitted from one market to another. • furthermore, market participants can now react very rapidly to a problem in a particular country, or even a perceived problem. capital can move rapidly and in large volumes. again, a disturbance in one country can now flow rapidly to other countries with the result that other countries ’ financial systems, and the international financial system more generally, are arguably more exposed to disturbance than before globalisation. in the light of these increased

are reviewing the scope for managing capital flows. capital controls may be appropriate in some circumstances, perhaps to mitigate problems arising from temporary surges in capital inflows in economies with weak financial sectors. for a debtor country like new zealand, an open capital account is essential. introducing capital controls, instead of making the necessary adjustments, would damage the credibility and bis central bankers ’ speeches stability of new zealand ’ s financial sector, and increase the real cost of capital for new zealand. reducing interest rates can at times reduce pressure on the exchange rate but analysis of past ocr cuts in new zealand shows on average minimal or no intra - day impact on the exchange rate, and even less impact on a weekly basis. analysis of “ unexpected ” ocr changes with trade weighted index changes following a rate decision still does not show a strong relationship to subsequent movements in the exchange rate. this reinforces the idea that the exchange rate primarily reflects returns in the broader economy rather than simply returns in the money market. we set the ocr such that the inflation outlook remains consistent with the pta and the financial markets understand this. if we reduced the ocr without sound reasons the exchange rate might drop initially but rise later when the inflationary implications of the rate cut became clear, especially if the belief was formed in the meantime that the central bank ’ s commitment to price stability was wavering. foreign currency intervention is unlikely to have a sustained impact on the new zealand dollar, but can have an impact in the short term if the reserve bank makes the right calls about the exchange rate departing from fundamentals. the reserve bank has four criteria to assess whether intervention should be undertaken. these are : whether the exchange rate is exceptional relative to history ; is the exchange rate justified ; would intervention be consistent with the pta ; and whether the market conditions exist to successfully shift the value of the currency. even if the first three criteria are satisfied at a point in time, it makes little sense to risk incurring losses to taxpayers by intervening when currency flows supporting the new zealand dollar are particularly strong. but we will remain vigilant on these criteria and will be prepared to intervene if all conditions are met. so there are clear limits to what monetary policy and exchange rate intervention can do to lower the new zealand dollar. in order to achieve a sustained reduction in the new zealand dollar it would be necessary to alter the overall level and pattern of saving and investment in the economy. in particular, it will be necessary to tackle our