5 it is a brave central banker who would deliberately induce a recession in order to head off the mere risk of a future financial correction. for instance, william white ( 2006 ), “ is price stability enough? ”, bank for international settlements working paper 205. alan greenspan ( 2002 ), “ opening remarks ” in rethinking stabilization policy, federal reserve bank of kansas. charles bean, matthias paustian, adrian penalver and tim taylor ( 2010 ), “ monetary policy after the fall ” in macroeconomic challenges : the decade ahead, federal reserve bank of kansas. bis central bankers ’ speeches that explains the interest in deploying additional policy instruments that are better suited to restraining the build - up of dangerous financial imbalances and contributing to the maintenance of financial stability – so - called macroprudential tools. with two targets – price and financial stability – one really wants another instrument, or set of instruments, to complement monetary policy. in the new arrangements established following the crisis, the deployment of such instruments falls to the bank ’ s financial policy committee. there are several potential macroprudential tools to deal with such cyclical risks, but they are of broadly two types : those that increase the resilience of the system ; and those that work pre - emptively against a build - up of leverage. in addition, measures may be targeted or more general in impact. to give some examples, first consider the basel iii counter - cyclical capital buffer, implemented in the european union under the capital requirements directive. by forcing banks to hold extra high - quality loss - absorbing capacity during a credit boom that can be released during a subsequent downturn, this primarily improves resilience. but because it raises the marginal cost of bank funds, the counter - cyclical capital buffer should also inhibit the build - up of leverage in the first place. there are several reasons why debt finance is cheaper than equity finance, including the implicit subsidy from being too big to fail, and the advantageous tax treatment of debt. moreover, debt pays the same return in all states of the world except when default takes place, while the return on equity will vary ; that makes debt more attractive for some investors, especially during financial booms when the probability of default appears low. raising the capital requirements on particular components of banks ’ balance sheets by varying sectoral risk weights is different in that it alters the relative attractiveness of different sorts of lending. assuming that the increase in capital requirements is

identify the main functions that need to be performed in each jurisdiction to promote financial stability. then we can look at the bank ’ s own institutional mandate. and finally we can determine the most appropriate way to fulfil it. i ) the three essential functions for public authorities there seem to me to be three essential functions to be carried out in securing financial stability : i think this is the case in most jurisdictions. firstly, there are the roles relating to supervision of firms and markets where financial instability could arise. secondly, there is the oversight of the financial system as a whole - the systemic issues which could impinge on society. and thirdly there is the fiscal underpinning which may exceptionally be required to restore confidence in the event of failure. the fiscal underpinning is a role for ministries of finance. the other roles can either be combined institutionally or separated. i am sure each model is represented here today. in the uk, hmt has responsibility for the fiscal underpinning, fsa for the supervision of firms and market regulation, and the bank of england for the stability of the system as a whole. ii ) the “ must dos ” for the bank of england the roles as such are set out with slightly more precision in the mou, and it is from there that we start on our quest to decide what initiatives we – the bank of england – should undertake, and how far we go with each. the mou highlights three “ must dos ” for the bank. i expect that these are similar in many central banks. they really define our mandate. a ) assessment of threats to financial stability firstly we need to assess the threats to the financial system. we need to be in a position to inform ourselves and to advise hmt at all times on the implications for uk financial stability of developments in both the domestic and international market places. we do this by continually assessing threats to the system as a whole – “ oversight of the systemic conjuncture ” if you like. so we look beyond the risks in relation to individual institutions, to the aggregate problems that can arise : through networks and single points of failure ; through dependencies and interdependencies of firms and markets. in other words to areas where, if market forces and market participants are left to their own devices, problems could threaten the stability of the system. this means that we need to have our finger on the pulse and to maintain regular contact with key firms and infrastructure providers. market intelligence is vital in this