If the slightest exchange rate movement will prompt an intervention persistently, the market’s perception of this greater stability of the exchange rate may limit the power of monetary policy. For example, fighting an asset price bubble, by raising the interest rate while intervening at the same time to prevent a larger appreciation, may be counterproductive, because the incentives for carry trade positions may exacerbate the bubble and the exchange rate appreciation itself. 3  3  This may explain the results about exchange rate instability presented in Batini and Nelson (2000), when the exchange rate is subject to bubbles which are dealt with via the interest rate. BIS Review 68/2009  5  Final remarks Financial stability must be preserved with an adequate regulatory system. Agencies must analyze the strength of institutions, while central banks must evaluate the system’s overall stability. Regulators and central banks must closely cooperate and work in the effort of maintaining the integrity of the financial system. Regulating specific institutions is not enough, because interconnections exist that could derive in a systemic crisis. The current crisis proves that the regulatory scope must encompass every agent with a systemic importance. So a proper macro-prudential regulatory system is needed. This is a system still in debate, particularly regarding the instruments that must be applied to achieve this function. A first set of instruments has to do with capital adequacy. However, this is not enough, and it is no trivial to judge the soundness of the financial system by its capital and leverage levels.
Such developments can create difficulties for emerging markets through spillover effects, large and persistent capital inflows, and the risk of sudden stop and capital reversals. So, it is in this context that IMF surveillance on emerging markets, in addition to the new directions that we have discussed, should pay attention to the sources of the externally-induced risk and vulnerabilities, and to assist members, through Fund policy advice, on how best to prepare. To help emerging market members become better prepared for these risks, I have a few suggestions to make on the Fund’s current efforts. First, for the new direction on financial sector surveillance to be relevant for crisis prevention, it is important that the key systemically important economies participate. As with FSAP, this is an area that is likely to be a challenge. Ideally, most systemically important economies and those with potential financial vulnerabilities should participate if the new direction were to have a strong relevance to the global surveillance objectives. The second suggestion is in financial markets surveillance. Again, if surveillance is to have a strong relevance for emerging markets, we will need to have a more policy-oriented surveillance of the global financial markets, focusing on the key financial flows, and on keeping members informed of what the Fund sees as the current trends and risks in the global financial markets.