A long list of lessons on financial stability has emerged, though how to put them in practice is subject to an intense debate. The cooperation at a global scale is the key to solve current problems and addressing the future ones, but to maintain the spirit of cooperation among nations is getting more challenging as the memory of the crisis starts to fade away. Outlook for emerging market economies As we all know, capital flows to emerging market economies have intensified recently thanks to better growth prospects, interest rate differentials, and relative stability of financial institutions in these countries that proved their strength and flexibility to extreme shocks. As liquidity in the global financial system increases thanks to rapid expansion of high powered money in major currency countries, central banks of small open economies face the risk of losing control over monetary conditions. Policy rate hikes to contain inflationary pressures and restrain credit expansion are likely to lead further widening in interest rate differentials, thereby fueling even more capital inflows, more borrowing, higher asset prices and inflation. As a result, emerging market economies today face a growing risk of asset bubbles, excessive borrowing and inflationary pressures – all of which are threatening the financial stability. The problems facing countries with current account deficits are much challenging than the surplus ones, since they have to deal with both financial stability problems arising from the strength of capital flows and the risk of sudden stops.
The uncertainty there is evident, for example, in the banks’ difficulties with borrowing at longer maturities and in investors’ preference for safe government paper over what they perceive as more risky securities such as mortgage bonds. Even the short-term interest rate on the interbank market has risen sharply as a result of mutual distrust between banks, causing them to avoid lending to each other. As a result, the banks’ borrowing costs rise, access to loans decreases, and companies and households pay more for loans. At times, moreover, trading on certain segments of the fixedincome market has ceased completely. When such disruptions occur, the Riksbank has considered that special measures are required to restore the functioning of the markets so that the supply of credit is not jeopardised and the financial markets, and therefore monetary policy, can work more normally. The first sign: a shortage of treasury bills … The very first, very concrete sign of the financial crisis in Sweden was an acute shortage of treasury bills. The high demand for safe investments, especially in the United States, caused interest rates on American treasury bills to fall almost to zero. Even foreign investors then turned to European countries, including Sweden, to get treasury bills that gave a higher yield. The Swedish National Debt Office decided to implement additional issues of treasury bills. The funds from these extra issues are being used for reversed repo transactions with mortgage bonds (purchase of mortgage bonds with agreements to resell them within a specific period of time).