Exchange rate flexibility is a key component in any policy mix to reduce currency mismatches. Indeed, this is an example of a macroeconomic policy that also contributes to financial stability. In the case of Chile, and elsewhere in Latin America, we saw currency mismatches drop after currencies were allowed to float following the Asian crisis, as agents and regulators adjusted to increased exchange rate volatility (Figure 3). Indeed, bank regulation should not only incorporate currency risks explicitly, but also indirectly by dealing with the credit risks that arise from currency mismatches in the corporate sector. Finally, the growth in size and complexity of the financial system that often accompanies capital flows calls for a continuous process of revision in micro prudential regulation. One of the key elements to consider here is the scope of financial regulation and supervision. For a start, in periods of abundant foreign capital, intermediaries that have not accessed crossborder financing may begin doing so, lacking both the adequate regulation and internal risk management. Furthermore, if prudential regulation on traditional intermediaries tightens in these episodes, incentives are increased for by-passing these intermediaries. An additional  4  BIS central bankers’ speeches  element to consider is the speed at which financial innovations are incorporated into middle income economies. For sure, large global financial institutions have incentives to expand the scope of their financial services.
Many EMEs have been trying to mitigate the appreciation through exchange rate intervention, with partial success. Chile is one of the latest to join this group. Others have sought the use of capital controls or macro-prudential regulations, not only for exchange rate reasons, but also to avoid the buildup of excessive market or liquidity risk associated to the foreign exchange position. In January this year we announced a program of reserves accumulation of 12 billion dollars, about 5 percent of GDP. This measure had a dual purpose. On the one hand, it would relieve some pressures on the exchange rate, facilitating the adjustment of the economy to the current international environment. On the other hand, it would increase Chile’s international liquidity position to levels around 17 percent of GDP. Indeed, evidence shows that having a high level of reserves makes economies more resilient to financial turbulences, even though they are generally not massively used. Reserves act as a deterrent against sharp capital flow reversals.1 In addition, reserves allow central banks to credibly establish foreign currency liquidity facilities. These played an important role in normalizing both domestic currency and foreign currency short term debt markets in many EMEs during the recent global crisis. After an initial sizable depreciation, the peso has strengthened, for some days even reaching levels similar to those prevailing before the intervention announcement. This contrasts sharply with the experience of the previous period of reserve accumulation initiated in April 2008 (Figure 1).