Mr Bäckström discusses international financial stability Speech given by the Governor of the Sveriges Riksbank, Mr Urban Bäckström1, at a seminar at the South African Reserve Bank in Pretoria on 9 August 1999. *  *  *  Introduction Financial stability is a topical subject in the light of events in the past decade – years that saw financial problems in a number of European countries as well as in Mexico and Asia, the devaluation of the rouble and suspended payments in Russia, considerable turbulence in western financial markets and financial unrest in Brazil. The crisis in the international financial system developed, to cite President Clinton, from being “just a few small glitches in the road” into “the worst financial crisis in fifty years”. The problem is that crises will always be intrinsically difficult to forecast. Recall that the scale of the Mexican crisis in 1994 was foreseen by very few. In South-East Asia the onset, duration and scope of the recession were all missed by the forecasting community. In the last spring, no one had anticipated the extent of the turmoil in financial markets that would be generated by the Russian devaluation and moratorium. The ways in which rising credit spreads led to losses by highly leveraged investors, liquidity shortages and the virtual drying-up of some markets were generally not foreseen. The track record shows that there are many things we do not understand and cannot predict.
Their behaviour in this respect is more reminiscent of how the Riksbank acted in the early stage of the flexible exchange rate regime. The operations of other central banks, in the UK and Australia, for instance, are more akin to the Riksbank’s current practice. Comparisons of exchange rate fluctuations in different countries with a flexible exchange rate provide little evidence of any clear effects from differences in the monetary policy strategies. The Canadian dollar, for example, does not seem to have been more stable even though the Bank of Canada has focused more on the monetary conditions and made greater use of interventions. BIS Review 48/1999  2  Forces behind the flexibles exchange rate At the time of the departure from the krona’s fixed exchange rate in November 1992, the real tradeweighted exchange rate was overvalued. Inflation in Sweden had been higher than elsewhere for a considerable period and this had successively eroded competitiveness. When the flexible regime was introduced, the krona depreciated markedly; in the first six months the nominal TCW index weakened about 20 per cent. In that inflation in Sweden had already been brought more or less into line with the rest of the world and there were signs of expectations that it would remain relatively low, such a marked nominal depreciation exceeded what was needed to restore a reasonable competitive situation. Having previously been overvalued, the real exchange rate accordingly swung abruptly to an undervalued level and remained there for a long time.