The evolution of economic theory in response to the crisis A number of significant academic contributions during the 1980s had focused on the way optimal individual behaviour could change depending on what individuals expect other private agents to do.7 The presence of this interdependence between agents, or as it is called, strategic complementarity, leads to multiple outcomes. Each of these outcomes is a rational equilibrium, but ones that differ in their implications for social welfare. Panic-based bank runs and panicbased sovereign debt crises are examples of policy intervention being needed to avert “bad” outcomes during a financial crisis. To an extent this is not a new idea for policymakers – central banks have been acting to stave off panic-based runs on banks for centuries. But the financial crisis has shown that severe financial frictions can exacerbate strategic complementarities. Moreover, the financial sector nowadays is much more sizeable relative to the economy, and runs are correspondingly more costly. 3/7  BIS central bankers' speeches  Advances in the literature have made strides in incorporating these ideas into macroeconomic models, thus to providing a clearer theoretical framework for these types of interventions.8 Economic research has also evolved in its thinking of how central banks should respond to an emerging crisis, particularly when their standard monetary policy instrument, typically a shortterm interest rate, reaches its effective lower bound. At the lower bound, monetary accommodation cannot be provided through further reductions in short-term interest rates and policy must become non-standard. One option is to rely on forward guidance, i.e.

A third step succeeds later, and thus onward till a genius pieces the bits together and makes the decisive contribution.”16 Today, I have had the privilege of addressing such people – geniuses who have pieced the bits together and made decisive contributions. 1 Ricardo, D. (1817), On the Principles of Political Economy and Taxation, London: John Murray. 2 Sargent, T. & Wallace, N. (1976), “Rational Expectations and the Theory of Economic Policy", Journal of Monetary  Economics, 2(2): 169–83; Lucas, R., (1976), “Econometric policy evaluation: A critique”, Carnegie-Rochester Conference Series on Public Policy, 1: 19–46; Kydland, F. and Prescott, E. (1977), “Rules rather than discretion: the time inconsistency of optimal plans”, Journal of Political Economy, 85(3): 473–491. These models also provided the ground for structural econometrics, which allowed for policy analysis and the study of counterfactuals. See Hansen, L. P. (2013), “Uncertainty outside and inside models”, Lecture on receipt of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 8 December; and Sims, C. (1980), “Macroeconomics and Reality“, Econometrica, 48(1): 1–48. 3 Clarida, R., Gali, J. and Gertler, M. (1999), “The Science of Monetary Policy: A New Keynesian Perspective”,  Journal of Economic Literature, 37(4): 1661–1707. 4 6/7  BIS central bankers' speeches  4 Notably Kiyotaki, N. and Moore, J. (1997), “Credit Cycles”, Journal of Political Economy, 105(2):211–248 and  Bernanke, B., Gertler, M. and Gilchrist, S. (1999), “The Financial Accelerator in a Quantitative Business Cycle Framework”, Chapter 21, Handbook of Macroeconomics.