jose de gregorio : tackling the capital inflow challenge speech by mr jose de gregorio, governor of the central bank of chile, at the bank of spain, the ie business school in madrid, and cemla ’ s meeting of central bank governors of latin america and spain in buenos aires, the three of them in may 2010. * * * i thank the valuable comments of kevin cowan, pablo garcia and enrique orellana. the last few years have brought unprecedented challenges to macroeconomic management in small, open economies. the severe inflationary shock that began in 2007 was followed by the worst financial crisis since the great depression and a worldwide economic recession with no match in the postwar period. today, a while after the immediate resolution of the crisis, we face new challenges. on the one hand, some developed economies, whose public finances were severely damaged by the great recession, now face a period of drastic macroeconomic adjustments and, in some cases, uncertainty about how their debts will be restructured. on the other hand, a substantial segment of emerging economies, which suffered no permanent damages in the balance sheets of their households, firms, or governments, is currently experiencing what can be an incipient start of a credit and economic rebound. the new momentum of capital inflows mirrors this phenomenon. the current status of these inflows and how to deal with them are a substantial part of the challenges we face today and the substance of this document. capital inflows in perspective after the boom of 2006 – 2007, and the sharp collapse of 2008 and part of 2009, capital flows to emerging economies have picked up. investments in stock and fixed - income mutual funds in emerging economies have recovered and in some regions have exceeded pre - crisis levels ( figure 1 ). corporate bond issuance, which nearly stopped in the fourth quarter of 2008, regained their pre - crisis levels, starting from the second half of 2009 ( figure 2 ). international interbank credit flows also stopped falling by mid - 2009, although a significant recovery is yet to be seen ( figure 3 ). this is consistent with the relatively weaker balance sheets of international banks compared with increased investment possibilities of global funds and capital markets. summing up, with the financial crisis behind us, capital flows have returned to emerging economies, but it is not evident that they currently exceed their pre - crisis levels. financial asset prices have also reflected this process. in emerging markets, the price - toearnings ratio dropped during the crisis

an orderly retreat which inevitably relies on increasing discount rates at which future income streams are priced. this is particular true if some projects were only funded to begin with due to the exceptionally low interest rate environment, and / or if such investments were intermediated by fund managers who care not only about income streams, but also ( and mostly ) about short - term price fluctuations. here we will have an interesting discussion including papers by stephen morris, michael woodford, and gustavo suarez, which will enlighten us about the theoretical aspects to keep in mind when evaluating the broader consequences of asset purchase programs, as well as the empirical evidence regarding the effects of the risk - taking channel on the quality of loans originated. but this is not only a conference about monetary policy in developed economies. indeed, securities from emerging markets fit naturally into the category of riskier assets that are expected to be affected by investors ’ search for yield in an environment of low interest rates, as has been documented by a growing and exciting empirical literature. this will be the topic bis central bankers ’ speeches of the third and final session of the conference, and will include presentations by helene rey, simon gilchrist, and elias albagli. this topic is of particular concern for central bankers and policymakers in latam and other emerging regions, which have good reasons to be worried with the consequences of us monetary normalization in an environment where further exchange rate pass - through will put increasing pressure on our inflation targets, while at the same time interest rate pass - through puts increased pressure on subpar levels of growth. before giving an official start to our nineteenth annual conference, let me end by stressing a related but perhaps less appreciated aspect by which the events of the last few years have changed, i believe in both a fundamental and desirable manner, the way monetary policy is handled and communicated. and if you permit me, i will illustrate the point using the recent chilean experience. in chile, although economic conditions have been far less complex than in developed countries, we have also experimented with unconventional policies... and frankly, i think the experience has been successful. first, in response to the global financial crisis of 2008 the bank increased the supply of liquidity in pesos and dollars – through repos and swaps –, augmented the extensions of the swap program, and broadened the range of eligible collaterals. they were all measures designed to align market rates with the monetary policy rate and to mitigate foreign currency liquidity tensions. forward guidance was also