fifty years there has been a preference for rules to constrain policy makers, so as to avoid previous mistakes. australia ’ s experience, which is in line with the experience of english - speaking countries, has been different. medium - term orientation and monetary analysis whether characterised as “ constrained discretion ” or “ rule - based, but not rule bound ”, modern monetary policy frameworks accord central banks a certain “ degree of freedom ” in their decision making. to what ends should this freedom be put? to be clear, it is crucial that price stability is maintained over the medium term. but it is neither feasible nor desirable for inflation to be targeted on a short term basis. within the academic literature, this is recognised in the so - called “ flexible inflation targeting ” framework. 2 this framework explicitly foresees the use of monetary policy to smooth developments in economic activity over the business cycle, while anchoring longer - term inflation expectations at levels consistent with price stability. from the outset, such considerations were also recognised in the ecb ’ s strategy. we have always acknowledged the need to avoid excess volatility in output and nominal interest rates, which would have resulted from excessive “ fine tuning ”. 3 our approach is characterised by a medium - term orientation, which recognises that – given lags in monetary policy transmission and the inevitable short - term shocks to price developments – we should not attempt to j. taylor and j. c. williams ( 2009 ), “ a black swan in the money market, ” american economic journal : macroeconomics 1 ( 1 ), pp. 58 - 83. l. e. o. svennson ( 1998 ), “ inflation targeting in an open economy : strict or flexible inflation targeting? ”, victoria economic commentaries 15 ( 1 ). ecb ( 1999 ), “ the stability - oriented monetary policy strategy of the eurosystem ”, monthly bulletin ( january ). “ micro - manage ” price developments. rather we evaluate risks to price stability at the medium - to - longer term horizon. the literature has focused on the use of monetary policy to smooth output in the relatively shorter run. but the flexibility accorded by a “ rules - based, but not rule - bound ” approach can be oriented in other directions. for example, it can be used to contain financial imbalances, by applying the same approach as we adopt when facing other sources of inflationary pressure. if the slow accumulation of financial imbalances poses a threat to macroeconomic

to the agency problems of equity financing. 8 this highlights the risk of a “ race to the bottom ” towards a liability structure that would leave bank managers unchecked. it is therefore crucial that all sources of bank financing are subject to adequate monitoring. the economic literature clearly points out that exposure to credit risk should be left primarily to those actors who have the best information on counterparty risk, namely, shareholders and debt - holders, hence the new capital requirements and the bail - in rules. let me note however that inducing greater monitoring efforts is a necessary, but not a sufficient condition to mitigate excessive risk - taking. bank debt - holders have to be able to monitor banks ( market monitoring ), but by monitoring them and pricing risk correctly they are also effectively influencing banks ’ behaviour ( market influence ). making market discipline work calls for a more comprehensive regulatory and supervisory framework of which bail - in rules are only a part, even if a significant one. and since bail - in rules have confirmed that insured depositors are protected by deposit guarantee schemes, i. e. ultimately by the taxpayer, the banking supervisor can be represented as the public authority to whom insured depositors delegate the monitoring of bank behaviour. all in all, while a good resolution framework is needed, it can only be a complement, and not a substitute for market discipline and supervisory vigilance. what does the empirical evidence of the effect of bail - in on funding costs say so far? the evidence points to a possible increase in the cost of funding for senior unsecured debt. for instance, a recent survey9 suggests that under a bail - in regime investors would demand around 90 basis points more for a senior bond issued by a single “ a ” bank. the investors surveyed also expect that the implementation of a bail - in framework will lead to an increase in price differentials across issuers with diverse credit quality. however, all this has to be weighed against the offsetting considerations that i just described. indeed, econometric results undertaken at the ecb for a sample of european banks suggest that the announcement of the directive had so far limited impact on the cost of senior unsecured debt. but for the financial sector, there are still two sources of uncertainty with see m. dewatripont and x. freixas ( 2012 ), “ bank resolution : lessons from the crisis ” in m. dewatripont and x. freixas ( eds. ), the crisis aftermath