Points in the upper right and lower left quadrants signal monetary and macro-prudential policy operating in the same direction; points in the upper left and lower right, these policies operating in opposite directions. The points are fairly evenly scattered across all four quadrants. This tells us that the right macroprudential/monetary policy mix depends critically on the relative needs of the economy and the financial system. But two arms beat one, hands-down. Institutional arrangements and macro-prudential policy Finally, if macro-prudential policy is a useful addition to the policy toolkit, who should have control over it? Here, a comparison with monetary policy experience is illustrative. Macro-prudential policy faces many of the same dilemmas as monetary policy. The most serious of these is the time-consistency dilemma [Kydland and Prescott, 1979; Chari and Kehoe, 2013]. In the monetary policy sphere, this manifests as a desire to loosen policy today to support the economy when tightening to control inflation tomorrow would be more appropriate. In the macro-prudential sphere, it manifests as a desire to loosen regulation to support today’s growth when tightening to counter tomorrow’s crisis would be more appropriate. In both cases, policy faces an inter-temporal trade-off in its objectives – a myopia trap. The time-consistency dilemma is likely, if anything, to be even more acute when fighting crises than when fighting inflation [Haldane, 2013]. The reason is that credit cycles last at least twice as long as business cycles. The myopia trap for macro-prudential policy is even more painful than for monetary policy.

Rajan (2005), “Has financial development made the world riskier?” Proceedings of the FRB Kansas City Jackson Hole symposium “The Greenspan years: Lessons for the future”; and F. Allen and D. Gale (2007), Understanding financial crises, Oxford University Press. 19  See: G.B. Gorton and A. Metrick (2009), “Securitized banking and the run on repo”, Yale ICF working paper no. 09–14. BIS Review 45/2010  7  element of truth in this characterisation. But the conditionality of such pre-commitments on the state of the economy may prove hard to communicate. Financial intermediaries may interpret pre-announced paths as a liquidity guarantee, promoting the excessive risk-taking behaviour I have discussed. Such behaviour may then limit the future flexibility of monetary policy-makers to react promptly to changed circumstances. All in all, such pre-commitments are not useful and, may even be damaging. Effective central bank communication should allow market participants to understand the decision-making framework. But a pre-commitment to a future path of short-term rates is best avoided. It limits the flexibility of policy-makers – operating within a transparent, rules-based framework – to take decisions as conditions evolve. Looking back over recent years, it seems likely that the adoption of such pre-commitments by some central banks led them to tighten policy too late and too slowly, thus helping to maintain the overly loose monetary stance that fuelled financial imbalances. 3. Assessing economic conditions  Even with the most sophisticated models of the economy, policy-makers are still heavily reliant on an accurate assessment of the conjunctural situation.