Bankers have every incentive to figure out ways to circumvent regulatory constraints and, if the restraints on behaviour are deemed onerous, activity is likely to shift outside the regulatory perimeter. It may be possible to design policies which embed incentives to comply rather than evade, and smart supervision can help. But there could be occasions when tighter monetary policy is the only way to reach those parts of the financial system beyond the reach of regulation. In such cases, if other policies are not available, then “leaning against the wind” may be the only option left. As the simple analytical framework used earlier makes clear, tighter monetary policy reduces both aggregate demand and credit supply, while tighter regulatory policies do the same. But the empirical evidence suggests the impact of interest rates on credit is generally relatively weak, while capital and liquidity regulation have a very direct impact on leverage and maturity transformation and thus on the resilience of the financial system. So my sixth lesson is: both monetary and regulatory policies are required to maintain price and financial stability; moreover, monetary policy should remain focused on the control of inflation, while regulatory policies should be assigned to maintaining financial stability. Much is sometimes made of the risk of monetary and macroprudential policies pulling in opposite directions if they are assigned to different agencies.

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