economy, it must seek to resolve what is termed the “ impossible trinity ”. in this, one of three desirable goals – capital market opening, fixed and / or stable foreign exchange rate, and monetary policy autonomy – must be sacrificed if the two others are to be achieved. thus, once capital market opening has progressed, a dilemma arises – a choice between foreign exchange stability and monetary policy autonomy. the first option for responding to capital flow volatility may be to use the exchange rate as an automatic stabilizer under a freely - floating regime. allowing the rate to move freely at all times can prevent excessive inflows by dampening appreciation expectations. but the real economy may be unable to adapt to large exchange rate swings within a short period and may be negatively affected. a country may intervene to limit exchange rate volatility or to slow the currency ’ s appreciation. but siphoning off the liquidity injected through sterilization may damage the central bank ’ s balance sheet and attract further inflows by maintaining a gap between domestic and international interest rates. as a last resort, capital controls may also be considered as a few countries have introduced recently. but as a recent imf study notes, decisions on their use should be made very carefully. the distortions and costs capital controls incur must be compared with their benefits, though they may form a useful part of the policy toolkit. 2 experience of capital flows and policy responses of korea in this vein, i would like to look back over korea ’ s experiences with volatile capital flows and policy responses. capital inflows during the early and mid 2000s after korea pulled out of the asian currency crisis of the late 1990s, capital flows shifted back to an increase beginning in the early 2000s, due mainly to foreign portfolio investment rather than direct investment, which is inherently more stable. equity investment led the portfolio inflows in the first half of the last decade. this was encouraged by the prevalent low interest rates in advanced countries, abundant global liquidity, and korea ’ s sound economic fundamentals. between 2006 and 2007, however, bond investment inflows took on a more dominant role than equity investment, greatly helped by the increased arbitrage incentives for bond investment. as a result of these large capital inflows, pressures for the appreciation of the korean won persisted. 3 this coincided with an expansion of private sector credit and a steep run - up in housing prices. in response, beginning in the first half of 2006, the korean

policy will be strengthened by the shift from the current establishment of an annual inflation target to a system of selecting an intermediate ( 2 ~ 3 years ) inflation target. thirdly, the safety and efficiency of payments and settlement system, which are crucial to financial stability, will be augmented by assigning the responsibility for their oversight and overall management to the bank of korea. all in all, the revised legislation will bring the korean central banking system much closer to convergence with the global standards demanded by the oecd, imf and other international organizations. it is also forecast to contribute to raising the country ’ s international credibility. in the years ahead, the bank of korea will re - double its efforts to ensuring the stable development of the national economy through the even more efficient conduct of monetary and credit policy from a position of neutrality. at the same time it will do its utmost to strengthen the policy capacity and to augment the transparency and accountability of the policy decision - making process so as to react in a highly effective manner to the rapid changes and the mounting uncertainties of the financial and economic environment. in doing so, it will win the reputation of being a central bank that enjoys the firm confidence of the general public.