markets contracted due to the increase in counterparty risk perception, ending in a flight to government - backed assets. as professor robert lucas has clearly pointed out, this financial crisis was very similar to that during the great depression, in which credit froze due to the fall in bank deposits originated by the bankruptcy of many financial institutions. however, unlike that episode, this time, the fed did not allow a contraction of highly demanded liquidity. 3 in particular, the fed used conventional monetary policy to reduce the fed funds interest rate from 5. 25 percent in july 2007 to levels close to zero at the end of 2008. since the second half of 2008, as an extraordinary measure, the fed also bought a significant amount of illiquid ( and low - quality ) assets from financial intermediaries in exchange for liquid reserves held by them at the central bank. these operations confirmed that monetary policy tools are not exhausted when the policy interest rate reaches zero. under such circumstances, conventional monetary policy is ineffective because it involves operations with short - term government securities which, by paying a rate close to zero, become quasi - money and therefore the central bank cannot supply liquidity effectively through open market purchases. the overall strategy contributed to the dissipation of financial panic by the end of the first quarter of 2009, as reflected by the reduction in the spread between the cost of private financing and that of public financing to levels close to those prevailing prior to the crisis. 4 see robert e. lucas, jr., op. cit. for example, the spread between the 3 - month libor rate and the overnight indexed swap, which reflects the banks ’ funding cost as compared to the central banks ’ reference rate, began to increase in august 2007, reaching their highest mark of 364. 4 basis points during the fourth quarter of 2008, and then decreasing to 36 basis points ( pre - crisis levels ) by the second quarter of 2009. bis central bankers ’ speeches the effect in spite of the towering financial turmoil was that gdp fell significantly less than during the great depression but, unlike that time, there was no deflation. although the central bank ’ s intervention as a lender of last resort was effective, it was not free of costs, as the bail - out of low - quality asset holders created incentives for excessive risk taking in the future, a problem known as “ moral hazard ”. nevertheless, this cost might have been lower, at least in the short term, than that if financial panic had not been

well know, usually are the source of major crisis. the avoidance of this scenario through reserve accumulation has been an effective prudential instrument. figure 7 net non - resident holdings of emerging markets ’ government bonds percentage of international reserves mar - 15 aug - 14 jan - 14 jul - 13 dec - 12 jun - 12 nov - 11 apr - 11 oct - 10 mar - 10 aug - 09 feb - 09 jul - 08 dec - 07 source : ministries of finance, central banks and other national authorities. note : average percentage of foreign holdings on local bonds for the following countries : mexico, brazil, indonesia, malaysia, thailand, poland, turkey, israel, hungary and south korea ( since december 2009 ). of course, in some cases macroprudential measures applied through the banking system ( like loan to value or income to debt limits, and the imposition of higher reserve requirements ), could deliver the same results, and several emes have followed this path. nevertheless, macroprudential policies are far less effective when capital flows are not channeled through the banking system, as has been the case with recent cross - border flows to many emes, where market - based financing has been the norm. as time passed, a gradual deterioration in some emes macrofundamentals, in combination with some major events in aes that periodically switched the risk - on to off, and vice versa, ( such as the problems with greece and other countries in the periphery of the eurozone, the possibility of a fiscal cliff in the united states, the “ whatever it takes ” statement by mario draghi3 ) have made capital flows to emes increasingly volatile ( figure 8 ). see draghi, mario. 2012. remarks at the global investment conference. london. uk. bis central bankers ’ speeches figure 8 emerging economies : capital flows ( debt and equity ) weekly billion usd - 5 - 10 - 15 source : emerging portfolio fund research. in april / may 2013 the first serious reality check for emes arrived. at that time, the global financial cycle was more clearly transmitted to emes, triggered mostly by the start of the discussion of monetary policy normalization in the united states, that is the “ taper talk ”. this, together with the correction in commodity prices that has followed the economic slowdown in china and in most aes, invited a reevaluation of emes ’ prospects. the turbulence in emes ’ financial markets that followed was not homogeneous. the most