According to this hypothesis emerging and developing countries are unable to borrow abroad in their own currencies reflecting lower degrees of portfolio diversification at the global level to emerging currency denominated investments. Needless to say, borrowing in foreign currencies creates currency mismatch problem – increases in the cost of debt-servicing of foreign currency – denominated external obligations in cases of real exchange rate depreciation. The cost is measured in terms of the reduced purchasing power of domestic output over foreign claims following the depreciation. The original sin indicator depicted in Figure 5 shows that original sin level is much below that of the 1990s despite its rise since the beginning of 2012. BIS central bankers’ speeches  3  In other words, EMEs’ share of obligations in foreign currencies is well below those observed in the 1990s.7 Bailing out banks during the above mentioned EME financial crises put heavy burden on government budgets of EMEs. It was well-understood that banking sector plays a systemic role. In order to avoid bailout costs and disturbances to the intermediation of loans to real economy EMEs overhauled their banking sector regulatory and supervisory systems. These reforms tried to ensure that banks hold adequate capitals to be resilient to shocks and, in general, run their businesses in a prudent way. Figure 6 shows that leverage ratios measured as (risk unweighted) capital divided by total assets, on average, stayed above the average levels of the 1980’s and 1990’s and also the average ratio of advanced economy banks.
If a deregulation stems from political decisions that could not be predicted, or its effects on inflation are calculated to disappear in less than one to two years, it will not elicit a reaction from the Riksbank as long as the rule of action is adhered to. The situation is different, however, if the economy goes through a series of deregulations or the price effects of a single deregulation continue for several years. This may lead to inflation being below the target more permanently, which in turn ought to lead, according to the rule of action, to a downward adjustment of the instrumental rate. The stimulus from monetary policy acts through the usual channels. So all else equal, one can expect a fall in market interest rates, rising share prices, a stronger expansion of credit and so on. General demand rises, employment moves up, unemployment falls and the inflation target is fulfilled. When the price effects have waned, there is a risk, if nothing else intervenes, of inflation rising above the target. To counter this, monetary policy responds by gradually increasing the instrumental rate again. Market interest rates move up, share prices fall and the growth of credit slackens. In other words, the customary transmission mechanism now works in the opposite direction, leading to some fall in production and employment as well as in resource utilisation. Another component of the process is the higher inflation’s limiting effect on household real income, just as the lower inflation benefited household income.