paul fisher : recent developments in the sterling monetary framework speech given by mr paul fisher, executive director, markets, and member of the monetary policy committee of the bank of england, at the manchester economics seminar, manchester, 30 march 2011. all speeches are available online at www. bankofengland. co. uk / publications / speeches. * * * i would like to thank sarah ashley, roger clews, ronnie driver, tarkus frost, chris salmon, olaf weeken, iain de weymarn and richard whisker for their help in preparing this paper. introduction during the recent financial crisis and ensuing recession, the implementation of monetary policy has been the subject of intense debate. most visibly, that debate focused on the bank ’ s use of large - scale asset purchases – otherwise known as “ quantitative easing ” ( qe ) – as a monetary policy tool. but other aspects of the mechanics of setting policy have also been of great interest. in this paper, i want to focus on two issues which go to the heart of central banking : ( i ) the first concerns how the bank should seek to implement the monetary policy committee ’ s ( mpc ) decisions on the official interest rate ( known as bank rate ), so as to best deliver a flat money market yield curve between one mpc decision and the next. ( ii ) the second is about how best to provide liquidity insurance to the banking system as a whole, while also encouraging banks to manage their day - to - day liquidity needs, and subject to minimising the credit risk taken on the bank ’ s balance sheet. before explaining the bank ’ s thinking about these two issues, we need to lay out some basics about the bank ’ s objectives, and how it seeks to meet them using its balance sheet. the bank of england ’ s objectives and its balance sheet the bank has two core purposes : maintaining monetary stability and contributing to the stability of the financial system. with some variations, these are the two cornerstones of policy for most central banks around the globe. monetary policy is quite widely understood in a general sense – the bank specifically defines it to mean price stability and confidence in the currency. 1 financial stability is less well understood generally but it entails detecting and reducing threats to the financial system as a whole, in order to make it more resilient. 2 one major reason why it is for the central bank to pursue both of these purposes is because it has a balance sheet that can

we are aiming to preserve real value in swiss francs, not in local investment currencies. this means that a certain amount of positive return in local currencies is needed, if only to balance out the currency losses incurred in periods when the swiss franc is appreciating. to improve the long - term relationship between risk and return, government bonds in our portfolio are supplemented by the additional investment categories i have already mentioned. generally, the potential returns on equities are greater than those on government bonds issued by the major advanced economies. they can therefore make a contribution to preserving the real value of the currency reserves. to be more precise, equities increase the probability of preserving the real value of the currency reserves. this applies, in particular, in view of the current low ( or negative ) real returns on government bonds in core markets. so it is not surprising that equity investments have become more important for central banks in recent years. 1 how high should the equity share be? i will now talk in more detail about our investments in equity. so far i have explained why the snb invests in equity. in the next few moments, i would like to explore two questions : first, how high should the equity share in our portfolio be, in rough terms? second, how are investments carried out on the stock market? slide 6 shows that, between 2005 and 2010, our equity share was around 10 %. furthermore, you will see that, since 2011, we have gradually increased the share so that it now amounts to 16 % of foreign exchange reserves. when determining the equity share, the challenge is to optimise the risk / return relationship in the portfolio. as the saying goes among investors : if you want to eat well, buy shares, if you want to sleep well, buy bonds. the idea behind this old stock market saying is that, compared to most government bonds, equities have a higher potential return but are generally more risky. nevertheless, we need to begin by taking account of the diversification effect of the equity investments. the interrelationships can be seen if we look at the stylised efficient frontier path shown in slide 7. we start with a portfolio consisting solely of government bonds ( point a in the chart ), and then start adding equities to the portfolio. in the initial stages the risk and returns structure of the portfolio improves. the expected return increases and the expected risk decreases. however, once a given equity share