Increases to interest rates by the Reserve Bank of Australia (RBA) earlier in this decade helped maintain stability in the financial system, a top Bank for International Settlements (BIS) official says.
Jaime Caruana, general manager of the so-called central bankers' bank says use of the monetary policy alongside prudent regulation is necessary to maintain financial system integrity.
The RBA raised the nation's overnight cash interest rate four times, from 4.25 per cent to 5.25 per cent, between May 2002 and December 2003.
"Here in Australia, the Reserve Bank's interest rate policy in 2003 rightly erred on the side of tightness in the face of strong growth in house prices and credit," Mr Caruana said in a paper presented at the RBA's 50th anniversary symposium in Sydney on Tuesday.
"There was concern in some quarters at the time that this was straying from the goal of price stability.
"In light of experience, this shading of interest rate policy is better interpreted as having realised the Reserve Bank's stated goal of price stability over the business cycle."
In 2009, the RBA raised the cash rate by 25 basis points at each of its board meetings in October, November and December to the current 3.75 per cent.
Mr Caruana said nations with firm management of their domestic financial systems, such as Australia, had performed the best during the global economic crisis.
The Australian Prudential Regulation Authority (APRA) was established to supervise the local financial system in 1998.
"The strength of supervision mattered, not just the rule-setting," the former governor of Spain's central bank said.
"Even among the English-speaking countries, there is a striking contrast between Australia and Canada, on the one hand, and the United Kingdom and the United States, on the other.
"Contrary to the notion that strict regulation restricts competitiveness, the crisis shows that the financial systems of countries with strict supervision came out better."
The risk inherent in financial markets before the global financial turmoil had predated a broad-based drop in gross domestic product (GDP), Mr Caruana said.
"Just when risk seemed most remote on the basis of market indicators and complacency was at its highest, the system was most fragile," he said.
"Capital and liquidity buffers need to be built up in good times so that they can be drawn down in bad times."
International co-ordination of regulation, supervision and macroeconomic policy was needed to support global firms and world markets from unexpected shocks, Mr Caruana said.
"Just as risk management at individual firms does not add up to the stability of the financial markets, so, too, macroeconomic and financial stability at the national level does not necessarily add up to global financial stability," he said.
Mr Caruana said the more that confident markets believed they were mastering risk and uncertainty, the probability increased that things "will again go unimaginably wrong".
"So the best way to ensure that the next time really will be different is to avoid, at all costs, the thought that the next time will be different," he said.
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