2  BIS Review 52/2006  Perhaps the foremost advantage of having a fixed exchange rate regime as a means of keeping inflation under control is that it makes the task of monetary policy simple and straightforward: it shall set the key rate in a way that enables the exchange rate relationship to be maintained. This task is also easy for the general public to understand. At the same time, it may be a disadvantage that monetary policy is tied to this single task. It cannot then be used to subdue domestic disruptions that have no equivalent in the country to which the currency is tied – the anchor country. At the same time, disruptions in the anchor country will immediately affect the targeting country as interest rate adjustments in the anchor country will lead to corresponding interest rate adjustments in the targeting country. If, for instance, the interest rate in the anchor country is raised because demand in that country is increasing, the interest rate in the targeting country must also be increased in order to maintain the exchange rate relationship, even if the country is in a recession. A fixed exchange rate regime thus means that it is not possible to conduct an independent monetary policy. The task of keeping the economy in balance and of steering inflation more directly cannot thus rest with the central bank. A fixed exchange rate relationship can also be exposed to speculative attacks if it is not entirely credible.
4 One strategy for maintaining financial stability can briefly be described as consisting of three different parts: a clear regulatory framework, an efficient day-to-day prudential supervision and oversight and a preparedness to act strongly and quickly in a crisis. Exactly what role is played by the central bank in this strategy is also something that varies from country to country. Many central banks contribute in different ways to the formulation of the regulatory framework for the financial system, for instance, by giving their views on proposed bills and by participating in committees where domestic and international legislation is formulated. With regard to the day-to-day prudential supervision and oversight, one solution that is applied in Sweden and other countries is that the supervision of the financial sector is delegated to a special, independent authority with the power to apply sanctions. In other countries the supervision work is done by the central bank itself. In the cases where supervision is delegated to an independent authority, the central bank usually has an oversight role that entails regularly monitoring and analysing developments in the financial sector and presenting its views of the risks in the financial system. Ever since the bank crisis at the beginning of the 1990s, this has been perceived as a very important task in Sweden; in fact, it could be argued that the bank crisis was allowed to arise partly because no authority previously had the specific task of monitoring the overall financial stability.