What are the lessons to be learnt from this recent experience?

• First, the authorities should react to macroeconomic warning signals by taking economic action on a timely basis. Delays in taking the necessary medicine can be very costly, also for other countries. For countries that have a pegged exchange rate, the authorities should not wait too long before changing the exchange rate if required by the economic fundamentals. In support of currency depreciation, fiscal and monetary policies should be tightened. This evolves a tightrope balancing act. On the one hand, monetary policy should be tightened sufficiently, and this policy stance maintained for long enough, to restore market confidence in the currency. This is the first order of priority. On the other hand, tight monetary policy, including high interest rates, also risk increasing bankruptcies in the corporate sector and adding to the financial duress of the banking sector. There is no easy solution to this dilemma.

• Second, the crisis has once more underscored the importance of a sound banking system in a globalized world. The Southeast Asian countries are certainly not alone in having weak banking systems. The promotion of effective bank supervision and setting of prudential standards have to proceed or go hand-in-hand with the integration of financial markets. Without a well-functioning domestic financial system, foreign savings in the form of capital inflows cannot be translated into efficient use domestically. Substantial capital inflows often lead to a marked increase in bank lending, at times linked to investment in a booming property market. If the banking system is poorly supervised, and without adequate prudential regulations, the banking system can end up with assets of poor quality subject to major price fluctuations, and a net exposure in foreign currencies. Weaknesses in the domestic banking system are often revealed in the case of a reversal of short-term capital inflows or major exchange rate changes and ensuing losses. If restructuring or liquidation of financial institutions become necessary, this may involve a sizeable fiscal burden.

• Third, greater transparency of economic policies and data, including net international reserves and forward positions, is necessary. If markets are to function efficiently, they have to have adequate economic information. Transparency reduces the risk of sharp changes in market expectations that might occur if unexpected bad economic information, e.g., the size of international reserves, or the financial situation of individual financial institutions, is suddenly revealed. Transparency also has a disciplinary impact on policy makers promoting timely policy adjustment. Transparency in economic policies is simply an essential element of good governance and should be promoted in all countries.

• Fourth, given the trade and financial links, a crisis in one country has a direct economic impact on other countries. For instance, the Hong Kong dollar came under pressure as currencies in the region had depreciated, and they had all abandoned their peg to the U.S. dollar, including the New Taiwan Dollar. Their increase in competitiveness made markets question whether the peg of the Hong Kong dollar was tenable. There were good reasons, however, why the Hong Kong dollar remained pegged to the U.S. dollar under a currency board arrangement; this had been an important anchor for exchange rate and monetary policies for "one country, two economic systems" and remained credible because of the strong fiscal and reserves position of Hong Kong SAR.

• Fifth, given the interlinkages between economies, countries other than those immediately hit by a crisis have an interest in open and candid discussions of economic policies, and possibly coordination of policies. This is most obvious at the regional level but, as the latest events have shown, it applies also globally.