the mpc to focus on maintaining price stability ; to pay attention to all relevant information ; to weigh up the risks ; to take timely decisions ; and to explain them clearly. moreover, clarity about the aims of policy and the transparency of the decision taking process give the mpc significant scope to influence the longer term interest rates set by the market. it ’ s a far cry from previous policy regimes, when the main players faced very different incentives. prior to 1997 the key decision makers were politicians, who both set objectives for monetary policy and took responsibility for the technical judgements needed to meet them. politicians can rarely afford the luxury of focussing on one objective to the exclusion of all others. attempts to win credibility by constraining their discretion, notably through setting monetary targets, were a fairly comprehensive failure. interest rate decisions have been the subject of some famous tussles between number 10 and number 11 downing street under successive governments. here is chancellor denis healey, writing in his memoirs3 about a spat with the prime minster of the day : healey, d ( 1989 ), the time of my life, michael joseph london. ‘ at this time my own relations with jim were shaken by an incident just after the party conference. on october 6 i had asked him to let me raise interest rates by another 2 per cent to the then unprecedented level of 15 per cent … he refused. i said i wanted to take the matter to cabinet that morning. ‘ all right ’ he replied ‘ but i will not support you. ’ nevertheless i insisted … ’ in the event this did not prove necessary : callaghan backed down, leading healey to comment wryly that ‘ this was the only time i have ever used the threat of resignation to get my way. ’ the new framework has taken the politics out of interest rate decisions without sacrificing democratic accountability or oversimplifying the policy process. it is an elegant institutional solution to the lengthy debate between those who favoured untrammelled discretion and those who advocated rules ( such as monetary targets ) ; one, moreover, which manages to respect the constitutional priorities of a parliamentary system. achievements performance over the six years since the bank became independent has been impressive. against the target of 2. 5 % for rpix which ran from 1997 until december 2003, average inflation was 2. 4 %. for 68 out of the 79 months, inflation was within 0. 5 percent of the target - below it for 42 months, above it for 30

. in the example, lowering haircuts from 20 % to 5 % raises the crisis probability by an order of magnitude, from less than 0. 1 to almost 1. in other words, a hands - off haircuts policy runs a significant risk of systemic collapse if haircuts are procyclically trimmed during the upswing. to prevent this, policy makers could seek to control haircuts directly. in the example, significantly greater resilience could be achieved by imposing a haircut limit of 20 %. alternatively, policy makers could seek to lean against the pro - cyclical tendencies of the financial system as systemic risk increases. the other two lines in chart 1 show different sets of activist policy intervention. both require banks to build up larger liquid asset buffer stocks in the event of haircuts being trimmed. this lessens the need for banks to hoard liquidity, so reducing system - wide liquidity stress. the two policies differ in how aggressively they respond to such excesses – “ weak ” and “ tough ”. either way, the effects are striking. even the weak policy shrinks the probability of collapse by more than half, whatever the initial level of haircuts. and under the tough policy, the financial system is effectively inoculated against haircut - induced pro - cyclicality. it may be over - optimistic to think policy could eliminate the adverse effects of haircut - induced pro - cyclicality. for example, we have little theoretical understanding of how haircut - based policies might affect banks ’ behaviour. and we have little empirical case law on the implementation of these policies. for example, haircuts policy might be circumvented by banks substituting towards unsecured finance. so any quantitative calibration of the effects of a haircut - based policy rule is necessarily tentative. nonetheless, the model simulations are suggestive – and, at least qualitatively, encouraging. bis central bankers ’ speeches chart 1 : aggregate haircuts and probability of a systemic liquidity crisis probability of a systemic liquidity crisis 0. 9 baseline 0. 8 0. 7 0. 6 0. 5 0. 4 0. 3 weak 0. 2 tough 0. 1 initial aggregate haircut ( h ) baseline'weak'haircut - dependent liquidity requirement'tough'haircut - dependent liquidity requirement source : gai, haldane and kapadia ( 2011 ). this financial network set - up can be used