martin redrado : latin america and argentina – the effect of international financial turmoil keynote speech by mr martin redrado, governor of the central bank of argentina, at the bank of russia, moscow, 26 june 2008. * * * emerging markets face definitely a hostile international financial scenario. the global economy is going through its worst stage in more than a decade. as i said over a year ago in basel when shocks first hit financial markets, volatility is here to stay. and we will witness its consequences for some time to come. credit markets in developed countries are still deteriorating. money markets continue to show signs of tension despite innovative tools generated by monetary authorities. libor and euribor rates are recording wide spreads compared to yields on low counterpart risk such as u. s. treasuries. this is largely due to credit risk perceptions among banks, with some degree of overshooting in financial institution spreads. current prices of banks ’ cds show that it will take time to correct this situation. as uncertainty regarding each institution ’ s exposure to “ toxic waste ” persists, banks continue to avoid lending among themselves. then, demand for liquidity as a precautionary measure to confront potential materialization of contingent liabilities is what predominates in the financial markets. even though exceptional central bank steps helped mitigating pressures at the most critical times, they are still insufficient to recover investor – or, even worse, consumer – confidence. in the u. s., current conditions show at least a substantial difference from previous episodes : the trigger to current turmoil is the real estate market. therefore, the adjustment is different and, maybe, deeper than before. the social sensitivity that arises from this sector is reflected in u. s. congressional initiatives, which attempt to generate an orderly resolution, calling upon the government, banks and investors to share the burden of expected losses. in the euro area, divergence is probably a reflection of disparities among member countries. while germany grows at higher - than - expected rates, mediterranean economies, at the other edge, are virtually stagnant. the credit cycle begins to show the first signs of what, in other times, were periods of credit tightening, especially due to an incipient deceleration in household financing. for these reasons, a reversal in the capital flows of banks from subsidiaries in the emerging world to meet liquidity and solvency requirements in their headquarters is something to closely monitor. we are witnessing a growing use

policies pursued by the fomc and the ecb are due to differences in circumstances – differences in initial conditions and differences in the mix and intensities of supply and demand shocks. nevertheless, the differences in mandates and strategies likely also matter and lead to the two central banks, in effect, selecting different points along the trade off between output variability and inflation variability – with the ecb opting for lower inflation variability at the expense of somewhat higher output variability. the ecb does not consider its policy as an inflation - targeting regime. it distinguishes its approach as a two - pillar strategy that includes a focus on money growth as well as on a medium - term inflation objective. still, its approach has much in common with that of inflation - targeting regimes. of course, even for a dual mandate, low inflation is the only long - run objective, assuming that monetary policy cannot affect the long - run levels of output and employment. the bank of japan has a unique challenge. initial conditions in japan are very different from either the united states or the euro area, and there are, in addition, severe limitations on the ability of monetary policy to respond conventionally to downward shocks to demand. output is well below potential, there is ongoing deflation, and growth has been stagnant for a long period. monetary policy responded by lowering the nominal policy interest rate to zero, exhausting the conventional opportunities for additional stimulus. yet, the economy remains weak and further monetary stimulus would be welcome. this is especially true given concerns about the sustainability of their fiscal position – very large deficits and a very high and rising ratio of government debt to income. a spillover from the united states and the global slowdown will therefore have a sharper effect on japan, to the extent that its monetary policy is unable to respond. however, even once the policy rate has been driven to zero, there is a potential for additional stimulus from monetary policy – from so - called unconventional operations, though there is considerable uncertainty about their effectiveness. in principle, this additional stimulus can be imparted by monetary policy operations in longer - term government or even private securities. the channels for the increased stimulus work through the imperfect substitutability of assets and expectations about future monetary policies. such operations could lower long - term rates relative to short - term rates, lower private rates relative to government rates, result in a depreciation of the yen, extend the expectations of lower short - term rates over a longer period, and lead