out to be significantly less important. 3. monetary policy and financial stability given the imperfect status of the economic literature, despite notable recent advances, what should monetary policy do with respect to financial stability? experience suggests a few general considerations that central bankers should take into account in the conduct of monetary policy. i will mention four. the first consideration is that monetary policy can itself produce negative effects on financial stability. as doctors are used to say, first try to do no harm. to understand this concept, we need to recognise that monetary policy can, via the interest rate, affect the intertemporal allocation of resources by influencing agents ’ incentives to borrow. however, there is a limit to this because economic agents cannot go on borrowing unlimited amounts from the future indefinitely. therefore, it is important to realise that the capacity of monetary policy to influence the intertemporal allocation of resources is constrained, particularly by the situation of agents ’ balance sheets. an agent – or a sector of the economy – that contracts a net debt has implicitly chosen to bring forward resources to the present, thus reducing them in the future, in order to pay off that debt ( provided, of course, that it does not intend to renege on its debt obligations! ). financial stability can be defined as a situation in which the intertemporal allocation of resources is felt to be “ in equilibrium ” or “ sustainable ”, which means that it is at the same time in line with the desires of individual agents and with the need to keep up with the debt obligations that have been subscribed. the central bank should not create the incentives for private agents to accumulate debt continuously over time. such an over - accumulation, especially in good times, may jeopardise its sustainability. private agents – no differently from the public sector – may experience solvency problems. we know that low lending rates tend to encourage banks to increase risk - taking, 8 especially when low rates are coupled with strong financial innovation. 9 for instance, when a financial institution has promised its creditors high rates of return but then faces a period of low interest rates that is expected to last for a long time, the only option open is to take on additional risk. another example relates to the typical compensation contract for investment managers, which depends particularly on the annual return achieved ( in excess of an agreed minimum ). when risk - free returns are high, compensation is also see the ecb ’ s june 2007 financial stability review. adalid and detken

reflect the role of monetary policy measures in providing a credible backstop against adverse tail risks – such as an arrest in the flow of credit to the economy and acute financial instability. however, building on recent advances in the macro - econometrics of estimating the impact of financial tail risks, preliminary results by ecb staff indicate that the ecb ’ s removal of the financial tail risk associated with the pandemic ensured a degree of support to growth that is several times larger than the impact derived by the more limited calculation shown in chart 3. [ 7 ], [ 8 ] in particular, as chart 4 shows, econometric analysis that quantifies the impact of a tightening in euro area financial conditions – not only on the mean of output growth but also on different parts of its empirical distribution through quantile regression – shows a negative impact on activity that is several times larger when the economy is experiencing headwinds than in a situation in which a tightening occurs during better economic times. [ 9 ] ecb analysis also finds that our measures have been crucial in preserving the flow of credit to the economy and preventing disruptive financial instability. https : / / www. ecb. europa. eu / press / key / date / 2020 / html / ecb. sp201126 ~ c5c1036327. en. html 4 / 19 01 / 12 / 2020 monetary policy in a pandemic : ensuring favourable financing conditions chart 4 impact on output of a tightening of credit conditions under different states of the economy ( year - on - year percentage changes ) source : ecb calculations. notes : the chart shows the response of real gdp growth to a tightening in financial conditions ( one standard deviation ) measured through a financial conditions index. the right panel shows the impact across quantiles of the gdp distribution. economic and financial challenges while the recent news on vaccines is very welcome and reduces the likelihood of the most severe scenarios, the current surge in infections and the re - imposition of containment measures serve as warning signals that the recovery path will still be long and fraught with risks. economic developments are likely to be unsteady and uneven across countries and sectors for some time to come and remain subject to elevated uncertainty. as chart 5 shows, the services sector is clearly bearing the brunt of the pandemic, especially those services industries ( including travel, tourism and entertainment ) that are most affected by social distancing and containment measures. chart 6 shows that the impact