Credit lines were closed, margin calls were made, and all but the safest assets sold off at fire sale prices. Emerging market assets experienced a sell-off as a part of this process, and funds were repatriated back to the US in order to meet margin calls and repay debt. In normal times, managing liquidity across currencies from countries with free movement of capital and relatively developed capital markets is not much of an issue. In these conditions, FX swap markets can speedily be used to convert liquidity from one currency to another at spreads that closely reflect the differences in domestic money market rates in the two countries concerned. In other words, the covered interest parity condition broadly holds. Visà-vis the US dollar, this relationship showed periodic strain for most currencies after the  BIS Review 9/2010  3  financial turmoil erupted in late summer 2007, but it broke down almost completely after Lehman. There are probably several reasons for this, some of which were analysed in BIS publications such as the Quarterly Review during the period when I was still there. 2 Thus, for instance, we know that before the crisis, European banks had a structural imbalance where they had invested in longer-maturity USD assets and financed them partly in USD interbank markets at shorter maturities. When these dried up, there was probably a scramble to get USD liquidity through FX swap markets, with the result that those markets became dysfunctional as well.
This is not a side issue for central bankers, as we are now in charge of financial stability as well as price stability. Moreover, a robust and profitable financial sector is one of the prerequisites for the proper transmission of our monetary policy. 1. Where do we stand in the euro area with respect to monetary policy? I am fully aware of the heated debate here in Germany surrounding our monetary policy. A debate that is fully legitimate, but let us try to keep it rational, and avoid getting emotional. “Mehr Licht!” (more light!) if you allow me to quote Goethe’s last words. This is exactly what I would like to do today: to shed light on our reasons and our progress. As you know, the ECB was shaped according to the model of the Bundesbank, and I do believe that the Eurosystem’s collective monetary policy is very much aligned with the German values that I fully share and admire: independence, respect of the Treaties, price stability and a longterm approach. As price stability is the mission entrusted to us by the European Treaties, we have a duty to make it our primary focus. Price stability means an inflation rate of close to, but below, 2% over the medium-term. This has been our definition since 2003, and it is a definition that most central banks in developed countries share – what Jean-Claude Trichet rightly terms as “a great convergence".