to provide some context. the bank ’ s current arrangements for the setting of monetary policy date back to 1997. at that time, i was involved, at the treasury, with the implementation of the reforms that gave the bank of england operational independence on monetary policy. our thinking in those days was very much dominated by the need for simplicity and clarity – “ one instrument for one target ”. the instrument was monetary policy ; the target was price stability. so the bank was given a statutory objective of maintaining price stability by hitting an inflation target. it was given new machinery, the monetary policy committee ( mpc ), with the power to set interest rates to achieve the target. over the mpc ’ s first ten years, the uk economy enjoyed a remarkable period of macroeconomic stability. there was only one month – march 2007 – where inflation was more than 1 percentage point away from the bank ’ s target. the annual rate of economic growth ran on average at around 3 %, with fluctuations little more than 1. 5pp either side of that. there was not a single quarter where economic activity contracted. bis central bankers ’ speeches but though the macroeconomic environment was stable, huge risks were building up in the financial system. there was an explosion in risk taking in the global financial system, much of which had an impact on the uk because of our internationally active banks and our position as international financial centre. over the ten years to 2007, the balance sheet of the uk banking sector nearly doubled relative to the size of the economy. by the time the crisis broke, the balance sheet of the uk resident banking sector approached 6. 5 times annual gdp. but though much of the risk came from abroad, there was also a substantial rise in domestic lending and domestic debt. house prices increased faster than people ’ s incomes – from five times earnings in 2000 to over eight times earnings by 2007. as most people borrow to buy houses, this drove up outstanding household mortgage debt from 50 % of gdp to around 85 %. household debt as a whole went from around 110 % of household income to over 165 %. commercial property prices doubled and lending to support commercial property investment trebled. should the bank have tried to rein this in? the mpc ’ s objectives made no mention of financial stability. much of the international thinking at the time was that central banks should not try to use monetary policy tools like interest rates to address asset bubbles and financial stability risks. rather they should deal with the consequences of such risks if they

that liquidity risk resided primarily in the banking sector. but as economies migrate towards more market - based forms of finance, liquidity risk is increasingly likely to originate ( or be concentrated ) elsewhere : including broker - dealers, central counterparties ( ccps ), or traded instruments themselves. the herd mentality that can develop during crises can sometimes only be tamed by well - designed intervention – be it covert or overt – using a credible backstop. countries lacking such backstops are likely to sustain large - scale, and preventable, economic damage. so the risk of central banks having “ too little ” scope to carry out lolr is real. at the same time, the public has a legitimate interest in avoiding “ too much ” lolr. we cannot afford for financial institutions to view liquidity support as a substitute for prudent financial management : central banks must not be “ lenders of first resort ”. and lending to institutions that are in need of capital rather than liquidity is the wrong solution. given the uncertainties involved, neither outcome can be avoided with certainty. but it is right to seek robust safeguards against them. bis central bankers ’ speeches a well - designed lolr framework must therefore get the balance right between lending “ too little ” and “ too much ” : – to help avoid “ too little ” lolr, central banks must be given clear responsibilities and the tools and powers needed to carry them out, including the ability to lend to individual institutions, covertly if necessary to maintain financial stability. – to help avoid “ too much ” lolr, central banks must have strong risk management, be ring - fenced from special interests ( in public or private sectors ), have a clear public mandate specifying their scope for action, and be subject to strong transparency and accountability requirements. there are powerful parallels between these design challenges, and those for monetary policy. like monetary policy, lolr is vitally important to an economy ’ s health, but involves intrinsically complex, technical judgments – including the solvency or otherwise of potential borrowers, the pricing, scale and maturity of loans, and the appropriate collateral. it is important that these judgments are made by experts. but, also like monetary policy, the consequences of these expert judgments have potentially wide - ranging effects on society. so they should only take place within a clear public framework of delegated authority. this combination of expert discretion within public parameters is sometimes termed “ constrained discretion ”. the large scale lolr