At a conceptual level, three arguments could be used to justify such a multi-pronged approach. First, banks are subject to multiple sources of risk or balance sheet fault-line. Historical experience suggests they fail for a variety of different reasons. To misquote Tolstoy, while sound banks tend all to be alike, unsound banks tend to be unsound in their own way. At least in principle, this could point to the need for 17  All speeches are available online at www.bankofengland.co.uk/speeches  17  different types of regulatory constraint to counter different balance sheet fault-lines: one instrument for each market failure. This is, if you like, the Tinbergen Rule as it applies to financial regulation (Tinbergen (1952)). Second, uncertainty as well as risk is pervasive in the financial system. These Knightian (1921) uncertainties have multiple sources - measurement of the risks banks face, how contagion propagates across the financial system and how regulatory actions affects behaviour, to name but three. A portfolio of regulatory tools can be seen as a means of offering insurance against these uncertainties. This is, if you like, the Brainard Rule as it applies to financial regulation (Brainard (1967)). Third, any individual regulatory constraint creates incentives for banks to respond in ways which may seek to avoid or arbitrage the rules. In the next section, we discuss how having multiple regulatory constraints might mitigate this risk. In this section, we discuss the conceptual case for multiple regulatory constraints before presenting some new empirical evidence. Table 2 summarises some of the key arguments.

Developing Ajello et al’s (2016) approach, the authors study an economy in which policymakers face a trade-off between stabilising inflation and output today versus keeping a lid on financial stability risks which threaten a crisis tomorrow. The optimal strategy is to adjust the CCyB in line with forward-looking indicators of crisis risk – credit growth in their model – but to relax (tighten) the CCyB relative to this plan if output is below (above) its target level. This strategy dramatically improves the inter-temporal trade-off facing a policymaker relative to the case where monetary policy is the only tool (Chart 23). Indeed, this is consistent with the Bank of England MPC’s guidance that monetary policy should be the ‘last line of defence’ in the presence of financial stability risks (Bank of England (2013)). The dashed lines show the steep trade-off facing a policymaker with a monetary policy tool only. Attempts to reduce the crisis probability with higher interest rates entail significant costs for current output and inflation. The solid lines show how this trade-off improves when the CCyB is added to the instrument set, even under conservative assumptions about the impact of the CCyB on the economy’s productive capacity. The variation in the CCyB required to deliver these benefits can be large. Given the historical distribution of shocks, the standard deviation of the CCyB is around 2 percentage points. A final strand of the literature has analysed whether the presence of macroprudential policy gives rise to coordination problems with monetary policy.