That paper cast the debate on the potential objectives of such a regime as a choice between ‘protecting banks from the cycle’ and ‘protecting the economy from the banks’. Macroprudential policy could focus narrowly on building resilience in the financial system in a dynamic way, so that it was better able to absorb large adverse shocks. Or it could pursue the broader and bolder objective of smoothing the swings in debt and asset prices associated with the financial cycle. The subsequent academic literature has usefully refined how we think about these goals of a macroprudential regime. One fruitful strand has focused on the pecuniary externalities generated by fire-sales in asset markets (Lorenzoni (2008), Jeanne and Korinek (2010), Bianchi and Mendoza (2010), Benigno et al (2013)). Collateralised borrowing leads to externalities because individual borrowers do not internalise the fact that increasing debt in good times raises the likelihood they will be forced to sell assets following adverse shocks, pushing prices lower, tightening collateral constraints and exacerbating downturns. These feedback and amplification loops can mean that private borrowing in good times is greater than a social planner would choose, facing the same constraints. That is the theory. Experience during the crisis tends to support the importance of these transmission channels. When highly-levered banks were forced to 31  All speeches are available online at www.bankofengland.co.uk/speeches  31  sell illiquid assets at highly discounted prices, this lowered valuations further and tightened constraints for other banks (Brunnermeier (2009)). This contributed to the depth and duration of the economic downturn.

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