This means that they are dependent on the path of economic fundamentals; in the case of government bonds, for example, the relevant factors include the budget balance, monetary policy and inflation expectations. Financial asset prices are highly susceptible both to expectations of how the market ought to move, given the underlying conditions, and to how it will move, given the expectations of how other players will act. This can result in wide fluctuations. Prices may deviate for a considerable time from what could be regarded as their long-term equilibrium. Markedly inflated prices can result in ‘bubbles’, out  3  BIS Review 52/1999  of touch with the level that seems to be fundamentally justified. Examples of this are the developments in some Asian countries in the mid 1990s, as well as price movements in the Swedish property market around the turn of the 1980s. To some extent, such phenomena can be explained in terms of how economic policy is conducted. But the causes of large price movements are also to be found in the construction of financial markets. If a market is to function properly, all the relevant information should be available simultaneously to every player. In practice, that is evidently not the case. Moreover, financial players can act in the knowledge that what they do will influence the market. The fact that performance is assessed in the short run, in many cases in comparisons with other players, makes herd behaviour common.
This is clear from the Asian crisis. The alternative is floating exchange rates. They have the advantage of permitting interest rate adjustments to the needs of the domestic economy. But they also entail exchange rate fluctuations and their drawbacks. The problem of exchange rate regimes is being discussed internationally but a consensus has not been reached. Financial market deregulation, moreover, must be adapted to the financial system of the country in question and supported by a consistent economic policy. To some extent, the developments in Asia probably had to do with an inappropriate sequence of deregulations; that was the case in Sweden in the 1980s and it resulted in problems. Short-term foreign currency loans made the countries vulnerable and subsequently resulted in currency outflows. The forms for deregulation have therefore been considered in the international discussions. The International Monetary Fund will be taking these aspects into account in future evaluations of individual countries. It is important, for example, that deregulations are accompanied by a reinforcement of the supervision of financial institutions and markets, so that any ‘bubbles’ are detected in good time. 2. Strengthening systems A sounder macroeconomic policy improves the conditions for making systems more robust. This is necessary but not always sufficient. A reinforcement of the financial system’s infrastructure is also needed. Such efforts are required both in the emerging markets and in the industrialised countries, as well as at the global level. The emerging markets must build up better systems for oversight and supervision.