##uating the capital inflows. however, it doesn ’ t always work this way. many countries do not allow their currencies to adjust fully. indeed, credit booms typically occur in countries with fixed and managed exchange rate regimes. 8 it is also possible that, even with a floating exchange rate, appreciations can perversely encourage further capital inflows, exacerbating the problem. this occurs through the “ risk - taking channel. ” 9 if domestic borrowers have local currency assets and foreign currency liabilities, an appreciation increases the value of their domestic assets and makes their balance sheets look stronger. this increase in perceived creditworthiness could lead to the provision of more foreign currency loans as capital inflows through the banking sector increase. in a similar vein, it has been argued that, even with a floating exchange rate, a country ’ s financial conditions depend primarily on a global financial cycle, limiting a central bank ’ s ability to use monetary policy independently to influence its economy. one scholar thus argues that mundell ’ s trilemma boils down to a dilemma : “ independent monetary policies are possible if — and only if — the capital account is managed, directly or indirectly, via macroprudential policies. ” 10 the most familiar examples of international capital flows enabling the buildup of domestic economic and financial imbalances come from emes. but this is not just a developing - country issue : think of the united states before 2008. the distorted incentives and regulatory weaknesses in the us financial system during that period are well known. in that context, the ability to borrow cheaply, at global interest rates reflecting high savings rates in china and other emes, contributed to a growing financial bubble. this pattern, and the ensuing financial crash in the world ’ s most sophisticated financial system, had many elements that are familiar from emes in the past. to sum up, while there are known benefits to financial openness, a country can reap those benefits only if it avoids some important pitfalls. if a country has major distortions in its financial system, perhaps reflecting weaknesses in regulations, opening the economy to capital flows may just feed those distortions. to turn this r. a. mundell, “ capital mobility and stabilization policy under fixed and flexible exchange rates, ” the canadian journal of economics and political science 29, no. 4 ( 1963 ) : 475 – 485. e. g. mendoza and m. e. terrones

david dodge : summary of the latest monetary policy report opening statement by mr david dodge, governor of the bank of canada, at a press conference following the release of the monetary policy report, ottawa, 14 april 2005. * * * this morning, we released our april monetary policy report. in the report, we said that the global economy has been unfolding largely as expected, and the outlook for the canadian economy is essentially unchanged from that in january's monetary policy report update. there is increasing evidence that the canadian economy is adjusting to major global developments, including the realignment of currencies and higher commodity prices. the bank expects canada's economy to grow by about 2 1 / 2 per cent in 2005 and 3 1 / 4 per cent in 2006, with growth this year and next coming primarily from strength in domestic demand. to continue to support aggregate demand, we decided to leave the target for the overnight rate unchanged at 2. 5 per cent on 12 april. the bank continues to judge that the economy is operating slightly below its production capacity, and we expect that it will move back to full capacity in the second half of 2006. core inflation is expected to return to 2 per cent around the end of 2006. based on the scenario implied by oil - price futures, total cpi inflation is projected to remain slightly above 2 per cent this year, and to move slightly below 2 per cent in the second half of 2006. in line with this outlook for growth and inflation, a reduction of monetary stimulus will be required over time. this outlook is subject to both upside and downside risks and to uncertainties. the risks include the pace of expansion in asia and the prices of oil and non - energy commodities. a further risk relates to the resolution of global current account imbalances. should these imbalances persist, the risk of a disorderly correction would grow over time. most of the uncertainties with respect to the canadian outlook relate to how the economy is adjusting to the relative price changes associated with major global developments. monetary policy continues to facilitate the adjustment process by aiming to keep inflation at the 2 per cent target and the economy operating near its production capacity.