However, such a decline may increase inflationary pressures and cause real estate bubbles and financial imbalances. Taking this trade-off into account, some economies in the region tend to choose the latter option – namely, a decline in the policy interest rates – reflecting concerns over volatile exchange rates and an excessive appreciation (or misalignments).
This is because high exchange rate volatility often leads to heightened volatility in output that in turn may well amplify the vulnerability of the economy. A volatile exchange rate also results in financial institution balance sheet fluctuations, thereby possibly destabilizing the financial intermediary functions.