of up to a number of years. in the medium term, with a horizon of one to two years, monetary policy can be used for smoothing economic cycles. and in the short run, immediate action may sometimes be required to safeguard the stability of the financial system. we can also order the three stability objectives according to the degree to which monetary policy is responsible for the eventual outcome. regarding price stability, monetary policy is fully responsible for prices in the long run. or to put it more simply – a broad - based and sustained rise in prices is always attributable to monetary policy. as for economic fluctuations, monetary policy can affect them, but it cannot control them entirely. 1 concerning the stability of the financial system, the role of monetary policy measures is mostly limited to crisis management, through reacting to increased liquidity demand and providing support to the banking system in times of crisis. in the longer term, central bank action does not determine financial stability directly, it is other factors, such as regulation, supervision, and incentive structures which determine the stability of the financial system. 2 i would also like to say a few words on the hierarchy of these objectives. it is sometimes argued that only one objective can be pursued – on the assumption that a central bank has only one instrument, usually a short - term interest rate. some objectives must therefore be subordinate to other objectives. in theory, this view is certainly correct. however, practice is more complex than theory. in practice, the problem of having more objectives than instruments in monetary policy is less severe than theory might suggest. there are three reasons for this. first, the three objectives are not necessarily contradictory. on the contrary, they are mutually conditional : a policy that ensures price stability in the long run also contributes to stabilising the economy and the financial system. second, even if the objectives sometimes appear to require a contradictory stance for monetary policy, it is possible – even with one instrument only – to successfully pursue several objectives. this is due to the fact that the impact of monetary policy on the different objectives occurs with different lags. to give an example : monetary policy action aimed at ensuring financial stability in the very short run or aimed at stabilising the business cycle over the medium term does not necessarily endanger price stability in the long run if the stimulus is removed in time and compensated for by a more restrictive monetary policy stance afterwards. in other words, there are several paths for the monetary policy instrument that are consistent with the long - term

central bank action is a first - aid kit to ensure that the patient does not die on the site of the crash from a loss of blood, but the subsequent healing process is up to the patient. taking moral hazard into account the final lesson concerns the moral hazard problem arising from liquidity management operations. roughly speaking, moral hazard is the name we give to the situation in which, financial institutions and investors incur higher risks than they would otherwise because they expect the central bank to intervene in times of crisis. this, in turn, may increase the likelihood of future crises. moral hazard is relevant both at the level of systemically relevant market players and at the level of markets as a whole. market participants that are “ too big to fail ” or “ too interconnected to fail ” may automatically factor in the help from central banks when deciding about their business strategy. however, smaller players and investors that cannot count on individual help may also take the expected central bank reaction to financial market crises into account in their investment decisions. because of moral hazard, central bank intervention in order to safeguard financial stability in the short term may be destabilising in the long term. therefore, when reacting to a financial crisis, the benefits of central bank intervention in terms of short - term stabilisation must be weighed against the long - term cost in terms of moral hazard. this is no easy task, because the future cost is unknown and far away, while an ongoing financial market crisis is a clear and present danger. recent events have clearly shown that moral hazard is not just a textbook phenomenon, but is in fact a serious problem. market players do indeed rely on the implicit insurance granted by central banks and other authorities, and central banks and authorities, having no choice, do indeed step in to support markets in a crisis. there is no easy way to address the moral hazard problem. however, the right time to tackle it is probably not primarily during a financial crisis, but during the preceding calm. since a strict declaration of no intervention by a central bank may not be fully credible, regulation must aim to neutralise the distortion of incentives which financial market participants face because of moral hazard. larger capital and liquidity requirements are probably a robust means of countering that distortion. larger capital and liquidity requirements do not eliminate moral hazard, but they limit the risk of an accident and thus the cost to the public in the event of a rescue. related to the moral hazard issue is also the issue of the risk - bearing capacity