But there is more to be done, and it is a long-term project. It is also necessary to drive home the point that bank directors’ role is not only to maximise short-term profits; as the system is currently structured, bank directors are also guardians of public goods as represented by joint financial market infrastructure. The third is financial literacy. A number of studies show that increased financial literacy enhances financial market stability, monetary policy transmission, and understanding of monetary policy actions. This is why the Central Bank has participated in and supported the preparation and implementation of Financial Literacy Week in recent years and intends to continue doing so. It so happens that Financial Literacy Week is underway right now. The fourth topic is discussion of what type of financial system we need and want as we emerge from the aftermath of the financial crisis. That includes the international aspect of the system, the scope of the system, and whether we need to shelter our infrastructure even more from risk-taking than we have already done with recent and planned reforms, including forthcoming legislation on insolvency and winding-up of financial institutions. In this context, there are other options available than the complete separation of commercial banking from investment banking. After important steps concerning capital account liberalisation are complete, which will be soon, there will be opportunities to say more about these topics and others. And now I have come to the conclusion of my speech today.
But transmission through the exchange rate channel is uncertain and volatile, as the exchange rate is also an asset price that fluctuates with speculative capital flows and can deviate from equilibrium over time, only to correct quite suddenly. Unless the financial system is that much better protected, this process can interact negatively with financial stability, as was the case in Iceland during the financial crisis. This is at the heart of the problem faced by small countries that pursue independent monetary policy and permit unrestricted capital flows simultaneously. The problem can be solved by adapting monetary policy to that prevailing in large countries even though it is not suited to domestic conditions, or by placing restrictions on cross-border capital flows, particularly those related to carry trade. The need for such restrictions is likely to surface earlier and more strongly in countries with shallow financial markets. But capital flow management measures that aim to restrict both carry trade and destabilising capital movements cannot be used as the first line of defence in the fight against inflation and macroeconomic imbalances, except under extraordinary circumstances. Such instruments will have adverse side effects and could push international obligations to their limits. But some sort of tools must be available for use if the need arises. In general, the first line of defence must be conventional management of the monetary-fiscal policy mix, supported by structural reforms and sound economic incentives.