MILO"CONTAGION EFFECTS[121 criticized for its failure to stem the fall of the peso and its adverse effect on the economy. The BSP was urged to loosen up on its defense of the local currency and to focus instead on bringing down interest rates, which was deemed to have a greater impact on the economy than the peso depreciation. The adjustment lag, especially in the response of banks, underscores the importance of maintaining the current low interest rate policy stance. One major outcome of financial liberalization in a regime of floating exchange rates was to increase the influence of financial markets in exchange rate determination, with financial flows vastly exceeding the value of international trade in goods and services. Financial markets clear or adjust faster than real markets, hence the overshooting of nominal (and real) exchange rates in the short run (Dornbusch 1976), in response to surges in capital inflows. Over time, as the impact of trade and industrial reforms become more fully realized, underlying structural changes should exert greater influence on the real exchange rate, moving it to a more realistic level. However, in the interim, macroeconomic policies-fiscal and monetary policies, external borrowing and exchange rate management" also play an important role because of their impact on aggregate demand and price levels, including the nominal exchange rate. Thus, they can either reinforce, neutralize, or even temporarily reverse the effects of structural changes on the real exchange rate (World Bank 1987). The choice of exchange rate regime depends on a number of economic and political factors, including the nature Ofdisturbances, the structure of the economy, the information available to agents, and policymakers' preferences. Central bank intervention in the foreign exchange market will have different objectives at different times. Given the changing environment, the alternative is no longer between fixed versus floating exchange rates. On the one hand, there is the difficulty and cost of maintaining
a fixed exchange rate in a
deregulated, globalized environment. On the other hand, leaving exchange rates to be determined exclusively in a market that does not always behave as an "efficient financial market", is also not