The buffer rate will be increased when financial imbalances are building up or have built up, thus bolstering resilience when we need it most. The countercyclical capital buffer can thereby have an impact on both the probability and the costs of a crisis. The buffer may thus also reduce fluctuations in the economy. We are now in a phase where banks are facing a number of new capital requirements. Banks can choose to adapt to the higher capital requirements by, for example, increasing lending margins or by tightening lending. Thus, higher capital requirements could curb economic activity in the short term. As the new requirements are phased in, the buffer will have to be adjusted to the economic situation and other requirements applying to banks. This does not mean that the countercyclical capital buffer should be changed frequently in pace with normal cyclical fluctuations. Once the buffer has been built up, the costs of maintaining capital levels will probably be low. The buffer rate should not be reduced automatically even if there are signs that financial imbalances are receding. This is in line with the international guidelines for the countercyclical buffer. The countercyclical capital buffer is only one of the elements in the new international regulatory framework for banks. The European Systemic Risk Board (ESRB) provides, among other things, for sector-specific capital requirements and limits on loan-to-income and loan-to-value ratios. 3 In New Zealand, the authorities have introduced limits on banks’ share of high LVR residential mortgage lending.

This has widened output gaps and depressed inflation. In response, policymakers have provided unprecedented degrees of policy support – in a number of advanced economies, double-digit percentages of GDP in both Quantitative Easing (QE) and fiscal stimulus. These actions should stimulate activity, shrink output gaps and boost inflation. Chart 1: CPI inflation projection  Source: Bank of England. Notes: Projection from February 2021 Monetary Policy Report, based on market interest rate expectations, other policies as announced. 1  For example, Batini and Haldane (1999). 2  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  2  It is these heavy weights on either end of the inflationary see-saw which give rise to unusually large uncertainties around future inflation. If the hit to activity were to prove larger or longer, even this degree of policy stimulus may prove insufficient to return inflation to target. But if economies bounce-back as the vaccination programme is rolled-out, policy stimulus could over-stimulate the economy and, with it, inflation. There are few, if any, historical precedents to help judge the response of the economy to this scale of shock and degree of policy stimulus. And the costs of getting these judgements wrong could be significant. Costs for the economy, if policy is set either too tight (resulting in lost jobs and income) or too loose (resulting in policy needing to be tightened more than expected, causing future losses of jobs and incomes). And costs for central banks in damaged credibility, if inflation targets were to be missed persistently.