In part, this is due to the differences in character between domestic and foreign savings. Those managing foreign savings are, understandably, much less concerned about the long-term public interest than those managing domestic savings. Foreign savings are also much more sensitive to changes in market sentiment and shifts in domestic policies, and are more prone to reversals. While this imposes greater discipline on local authorities in pursuing prudent macro-economic policies, it also brings much higher volatility in the financial markets, to the extent of possibly creating systemic problems that Asian monetary authorities are ill-equipped to handle. Furthermore, the foreign financial intermediaries are usually large international financial institutions with considerable market power and influence, in terms of the amount they are in a position to mobilise, relative to the size of the domestic financial markets of the emerging economies. This enables them to operate in the market not simply as price takers, but as a “price maker” with the power of pushing prices in a particular direction. The implications for the emerging markets are greater market volatility, greater tendency for overshooting, and consequently, greater challenges in maintaining monetary and financial stability. The problems are more intense for emerging economies with medium-sized financial markets that are large enough to attract foreign capital but not large enough to be immune from the manipulative or speculative plays that are, more often than not, associated with these fund flows.
Yet, a fundamental policy objective should be that the recovery of activity and the repair of the financial system have to be achieved in a manner that will ensure a sustained growth performance and will prevent the recurrence of episodes of financial imbalances and market excesses that can threaten again financial stability and economic welfare. Put differently, it is important that the policies and reforms pursued today lay the foundations for sustained growth. Let me now elaborate on these issues by focusing on the role and contribution of central bank policy and of financial system reform. Central bank policy The ECB’s monetary policy and provision of liquidity have played a key role in containing the downside risks to price stability, supporting economic activity and stabilising the financial system. The extent of the monetary policy easing since last October has been unprecedented, with key ECB policy interest rates having been reduced by 275 basis points. At the same time, money market rates have declined even more from the peaks reached in October 2008 as a result of the reduction in the policy rates and the provision of unlimited liquidity to banks at a fixed interest rate (against an expanded range of eligible collateral) since last October. At present, Euribor rates of maturities up to three months are below or very close to the main refinancing rate (MRO) of the ECB and at historically low levels – ranging between 0.93% (overnight) and 1.56% (3 months).