fx ) mismatches in balance sheets of the government, banks, or corporations. second, procyclical fiscal and monetary policies that amplify external shocks. in such cases, even a mild external shock can push economies to the brink of recession. ∗ i thank the comments and suggestions in preparing this note to elias albagli, miguel fuentes, and carlos medel. in short, domestic weaknesses interact with global financial attitudes in a dangerous mix that has historically proven to be highly destabilizing for emes, compared to aes. still, this characterization is based on very crude generalizations ; in reality, emes spread over a broad range of possibilities for each dimension and different combinations of them. the question is then to what extent does such variety of cases make a difference for the spillover from changes in global financial conditions and what role does the exchange rate ( er ) play in it. how important are global financial and business cycles to emes compared to local ones? to address this issue from an eme ’ s perspective, a first question refers to the relative importance of externally - induced shocks as compared to purely domestic ones. even if the global financial cycle were a very powerful force, as long as countries can still get into troubles of their own, macro policy, including the er regime, may make an important difference. a review of the last 40 years of economic history reveals many episodes during which cyclical turning points originated in domestic, rather than foreign, shocks. in latin america in particular, many of the major shocks of the 1980s, 1990s, and early 2000s originated locally, usually from misconceived policies, private sector exuberance, or inadequate regulations. the fact that these shocks showed up as large current account deficits surely reflects the degree of dependence of governments and business on external funding, but that does not exempt local conditions from being the main source of the imbalances. in particular, a classical latin american and caribbean countries ( lac ) crisis would show up as an unsustainable disequilibrium between public, private, or foreign savings and investment partially contained by some form of fx control, which turns into a major economic and financial crisis once the currency devaluates. abundant foreign capital may help prolong the situation for a while, but only to make the inevitable turnaround more damaging. it is important to underscore the role of domestic er policies. during the upswing, central banks in emes often try

be ruled out, hindering growth in other economies due to its weight in the global economy, and affecting commodity prices significantly. domestically, as aforesaid, medium - term risks for inflation are still present. the growth rate of domestic demand and output has dropped, albeit not as fast as expected. although the board estimates that output gaps have not narrowed further, if output again takes up a more dynamic path, there can be pressures pushing inflation up and demanding a monetary policy response. domestic demand has outgrown gdp in the last two years, thus widening the current account deficit. households ’ saving is low compared with earlier years, while corporate savings have decreased in the past year and investment is in record - high levels. if domestic demand becomes more dynamic, it could amplify the current account deficit. this could be risky in a scenario of weak world growth. as noted in our financial stability report, aggregate solvency and liquidity of the chilean economy remains stable. this is important, considering that banks ’ and enterprises ’ access to external credit could be hampered by a further deterioration of the global financial environment. in any case, and despite the impact of external volatility on the prices of some assets, financial markets have operated normally. in this context, i would like to highlight the need to continue advancing in initiatives to strengthen our regulatory and supervisory framework. one such case is the bill to reform insurance companies currently being debated in congress. the banks ’ solvency and liquidity indexes have been stable in the first half. in a context of good rents, core capital has hovered around 10 percent while regulatory capital – as measured through risk - weighted assets – around 14 percent. meanwhile, since the last financial stability report the banking industry has increased its long - term debt certificates, and some medium - sized banks have pursued strategies to attract retail deposits. another favorable development is the greater diversification of banks into different types of credit from abroad. also worth noting is the hoarding of liquid assets in foreign currency. the stress tests presented in our financial stability report show that the banking industry ’ s current capitalization levels allow it to cushion an episode characterized by a gdp slowdown, higher financing costs in local currency and an exchange rate depreciation associated with the materialization of the external risk scenario. as for household debt, it should be noted that, on aggregate, borrowing has increased in tandem with disposable income. this has translated into fairly stable aggregate debt indicators, whether comparing the debt level