Address by Dr Chris Stals, Governor of the South African Reserve Bank, at a Conference on "The South African Economy in a World of Volatile Financial Markets", arranged by the Bureau for Economic Research of the University of Stellenbosch, Johannesburg.   1. The contagion effectThe globalisation or international integration of the world's financial markets brought with it new challenges for monetary and other macroeconomic policies. The volatile conditions in world financial markets over the past two years created new problems for macroeconomic management in a number of countries. It was particularly smaller economies, with partly developed financial markets -- that is, the emerging markets of the world -- that were more seriously affected by these adverse developments.Ex post analyses of the financial crisis of 1997/1998 focused attention on purported deficiencies of macroeconomic policies, and of economic structures in many of the afflicted countries. From these lessons, programmes for a major reform of existing structures, particularly financial structures, and of essential adjustment in macroeconomic policies, are now emerging. At the same time, attention is given to a need for some restructuring of the global financial architecture with the objective to avoid a repetition of the 1997/1998 crisis in future. Crisis prevention, after all, is better than crisis solution.Without going into the details of the many proposals now being discussed at the global and national level for reforming macroeconomic structures and policies, pragmatism leads to the conclusion that the present globalised financial market structure is by its nature unstable, unpredictable and, with all its virtues and advantages, at times very disrupting for domestic national economic policy objectives.Easy communication through a world-wide network, the instant transfer of information on a real-time basis to all destinations, economic liberalisation and the transfer of resources such as surplus saving from more developed to developing countries of the world, have changed the environment in which macroeconomic policies must now be framed.Recent developments exposed an important aspect of this new global environment and that is the so-called 'contagion effect', or the ease with which economic problems that may develop in one country, region or functional group of countries, can be transmitted to others. The conduit for the transfer of the problem is not in all cases the same. Referring to the East Asian crisis of 1997/1998, at least three distinct transmission mechanisms can be distinguished in the contagion process: Firstly, there was the group of countries in East Asia, with many similarities and fairly intimate economic relationships, where individual countries were affected almost immediately after the Thai baht collapsed in the middle of 1997, partly because of perceptions and the herd-like reactions of international investors. In the case of this group of countries, contagion worked mainly through the withdrawal of short-term foreign financing to banking institutions, trade financing, and all forms of foreign loan facilities.Secondly, there was a further group of countries that was affected only gradually through a decline in the flows of portfolio investments from industrial to developing countries. Emerging market economies with fledgling capital markets were mainly affected with some time lags by the change in the attitude of the managers of major institutional investment funds who at some stage decided to convert high-yielding, high-risk assets into low-yielding, high-quality assets. South Africa is a good example of such a country that suffered in the wake of the East Asian crisis, mainly as a result of a large-scale withdrawal by non-residents of portfolio investments previously made in the country.Thirdly, another group of countries representing mainly exporters of primary products, metals and minerals, were affected with an even longer time lag by depressed world economic conditions created by the East Asian cum global financial market crisi