to be determined by market forces. it is therefore all the more important that this market process functions as efficiently as possible. and this is where the regulators come in. it is our job to make sure that the regulatory treatment of debt does not give rise to incentives that endanger financial stability. and it is our job to make sure that, if things still go wrong, the financial sector can still deliver its important services to the real economy. as the financial crisis and the euro - area sovereign debt crisis have shown, there is ample room for improvement here. in particular, we need to ensure that all actors bear the responsibility for their respective decisions. to me, three issues are of special relevance in this regard : the question of bail - in vs. bail - out, the regulatory treatment of sovereign debt, and the tax preference of debt over equity. 2. bail - in vs. bail - out let me start with a question that has been debated heatedly since the crisis broke out : the issue of bail - in vs. bail - out. the financial sector is unique in that a malfunctioning of this sector impairs the functioning of all other sectors of the economy. and the crisis has served as a stark reminder that a malfunctioning cannot be ruled out. some form of protection is therefore called for – otherwise, innocent bystanders in the real economy will inevitably get hurt. depending on the kind of malfunctioning, the central bank might be able to provide the protection. if the issue is a temporary dry - up of liquidity, it can act as a lender of last resort and supply the necessary funding – on an interim basis. but if the issue is one of solvency, then the central bank has no role to play, as taxpayers ’ money might be ultimately at stake. rather, it is then for politicians to decide whether to let a bank fail or not. providing insurance in the form of a bail - out comes with obvious moral hazard problems. if banks know that they are too big to fail, they are tempted to make the most of this insurance and take on excessive risks, at the expense of society at large. as the bank of england ’ s chief economist andy haldane put it : “ only in banking do control rights and incentive wrongs combine so uncomfortably. ” instead of the public providing cost - free insurance for banks, the onus is on banks to insure themselves against failure. only then are risk and reward

of output from potential, and inflation from target, compared to an environment in which the financial system had remained stable. in turn, this would call for more monetary policy interventions to stabilize output and inflation. effectiveness second, monetary policy is more effective when the financial system is sound. standard monetary policy determines marginal financing conditions in the short - term money market. its macroeconomic effects depend on several channels through which financial intermediaries pass on these policy rate decisions to the real economy. especially on my side of the atlantic, during the european debt crisis, these transmission channels became impaired. 8 this severely restricted the ability of policy rate cuts that central banks had implemented to stabilize the real economy. central banks ultimately had to resort to unconventional monetary policy tools, to restore the pass - through of lower policy rates to firms and households. 9 a sound financial sector therefore enhances the effectiveness of monetary policy by improving the functioning of the monetary transmission mechanism. it helps monetary policy achieve its objectives with less effort, and reduces the likelihood that the effective lower bound is reached. unintended consequences third, the more sound a financial system, the less likely it is that monetary policy will have unintended consequences. conversely, the weaker a financial system, the more likely it is that monetary policy actions will create unintended consequences. 8 a recent research paper by dnb economists illustrates this mechanism and shows that recapitalizing banks more quickly ( as it was done e. g. in the united states ) strengthens the monetary transmission mechanism ( m. mink and s. pool ( 2018 ) credit supply and monetary transmission after a banking crisis. mimeo, dnb ). 9 for an early theoretical analysis of this mechanism, see e. g. v. curdia and m. woodford ( 2011 ) the central - bank balance sheet as an instrument of monetary policy. journal of monetary economics, 58 ( 1 ). an overview of theoretical and empirical research on how the gfc was transmitted to the real sector, the nature of financial frictions and their impact on the transmission of monetary policy decisions can be found in m. gertler and s. gilchrist ( 2018 ). what happened : financial factors in the great recession, journal of economic perspectives, 32 ( 3 ). these unintended consequences of monetary policy for financial stability can occur through different channels. a first and much debated mechanism is the risk - taking channel of monetary transmission. according to this, monetary policy has a systematic impact on