high and rigid reserve requirements, and replaced it by daily, weekly and monthly auctions of monetary loans and deposits of commercial banks with the central bank. in the last two years we are gradually replacing these monetary auctions with treasury bills which will be our main instrument for conducting monetary policy vis - a - vis the market as a whole. judging from the results, the outcome is rather satisfactory : • israel enjoys price stability. • the foreign currency market functions smoothly, with relatively narrow spreads and low volatility. at the background, the central bank watches the market but does not intervene and the shekel, the domestic currency, is fully convertible. • the foreign currency position of the israeli economy is positive : the current account is roughly balanced ; fdi and portfolio investment started to go up again in the wake of the rebound in world financial markets ; and foreign exchange reserves held by the central bank are ample. to sum it up : the decision to regard the exchange rate as a policy instrument or let it be a marketdetermined variable is an integral part of the general strategy of macro - economic policy. in our case we let it be determined by the interbank market and used the short - term interest in its stead. a final word on the financial relations among mediterranean countries. while the potential for intraregional trade does not seem to be large at this stage, there seems to be some scope for furthering financial ties, especially under the auspices of the european central bank : • one example can be joint missions and consultations to review the stage of development of various financial markets. • another example, based on the trend toward a flexible exchange rate regime, is a framework for collaboration among central banks to promote the stability of the financial system and open information channels among supervision authorities. • a third example deals with the sequencing of liberalizing the capital account in connection with changing the exchange rate regime. the initiative of bank of italy and the european central bank should, therefore, be seen as a successful beginning. this is the most suitable forum to discuss and strengthen financial ties between the eurosystem and mediterranean central banks.

interest rates across key industrial countries in recent years supports this hypothesis. however, this co - movement in long - term interest rates might also be the outcome of global shocks which affect different countries in much the same way and, therefore, prompting similar national monetary policy responses. in this case, the co - movement in national longterm interest rates does not necessarily imply that central banks no longer exert an influence on their domestic long - term rates. 2. 3 credit channel the credit channel consists of several sub - channels with the bank lending channel and the balance sheet channel probably being the ones that have been most analyzed. whereas the bank lending channel concentrates on the supply of bank loans, the balance sheet channel looks at the effects of monetary policy on the overall supply of funds via borrowers ’ net worth. as concerns the bank lending channel, a number of studies document that financial innovation – such as securitisation or credit derivatives – have led to banks becoming more flexible in reacting to monetary policy. more specifically, they may have become able to better isolate their loan costumers from restrictive monetary policy impulses. 2 consequently, financial developments may have made the bank lending channel less important. however, to the extent that credit protection through credit derivatives is associated with an increase in bank credit supply the importance of the bank lending channel has not necessarily changed. for example, the possibility of transferring credit risk may not result in reducing risk from a see boivin, giannoni, mojon, “ how has the euro changed the monetary transmission? ”, nber working paper no w14190. see for example altunbas, gambacorta and marques - ibanez ( 2007 ), “ securitisation and the bank lending channel ”, ecb working paper no. 838. see for example hirtle ( 2007 ), “ credit derivatives and bank credit supply ”, federal reserve bank of new york staff report no 276. specific activity ( such as lending ) may increase that activity. in such a case, monetary policy would still operate through a bank lending channel as capital requirements would still be effective. according to the balance sheet channel, possible interest rate changes influence the creditworthiness of borrowers via the evaluation of their assets. creditworthiness, in turn, influences the premium that borrowers have to pay for external financing, and, thus, economic activity. while the analysis of the balance sheet channel was originally applied to non - financial institutions, the deep