– can breed complacency among financial market participants as risk taking adapts to the perceived new equilibrium. 6 indeed, risk appears to be at its greatest when measures of it are at their lowest. low variability of inflation and output ( reduces current financial var and ) encourages greater risk taking ( on a forward var basis ). investors stretch from liquid to less - liquid markets. in parallel, low and stable interest rates promote larger asset - liability mismatches across credit and currency markets. these tendencies are particularly marked if there is a perceived certainty about the stability of low interest rates. 7 many of these positions are funded on a collateralized basis. such asset - based financing creates intensely procyclical liquidity cycles. in these cycles, rising asset prices increase funding liquidity, which finances further purchases and prompts additional price increases. over time, haircuts are relaxed, further intensifying the cycle. 8, 9 it is important to recognize that expectations about monetary policy can feed these dynamics. it would appear that the so - called “ clean ” doctrine reinforces the risk - taking behaviour of agents. this is a strategy that advocates using monetary policy to “ clean up, ” or respond to, the consequences of a burst asset bubble rather than “ leaning into the wind, ” other factors include where the economy is in the cycle and the state of household and corporate balance sheets. they do so within a perceived risk budget. the actual risk budget has, of course, grown. either perceptions of risk or risk preferences could change. in the former case, complacency about actual risks can mean taking greater risks within the same risk budget. see diamond and rajan ( 2005 ). see gorton and metrick ( 2009 ), fisher ( 2008 ), and adrian and shin ( 2008 ) for comprehensive descriptions of these dynamics. ways to limit such procyclicality include enforcing through - the - cycle margins in repo markets and limiting rehypothecation margins in securities lending to 100 per cent. which would limit the progression of excess credit creation. 10 the combination of the central bank ’ s silence over the existence of a possible bubble, the certainty that it would not respond to emerging financial pressures unless they affect price dynamics over the monetary policy horizon, and the expectation that it would mop up if the bubble bursts all conspire to sow the seeds of the next crisis. 11 though they are far from the whole story, such dynamics are central to the

it is important to look through those temporary effects to the outlook further ahead. the discussion within the monetary policy committee is explained in the minutes of our june meeting which were published this morning. as ever, there is room for differences of judgement as to the appropriate level of bank rate – as shown by the differing views within the mpc. but every member of the committee is determined to bring inflation back to target and keep it there – or as close to the target as possible – indefinitely. in the long run, it is of the utmost importance that the right institutions to secure both monetary and financial stability are in place. i believe they are. chancellor, you are now moving on. our country continues to benefit from the institutional arrangements you introduced in 1997. as that great political commentator niccolo machiavelli noted, “ nothing brings a man greater honour than the new laws and new institutions he establishes ”. i encourage you to be equally bold in your next job. institutions outlast us all. over time, they are adapted as we learn the lessons of the past in the light of a changing present to meet our future needs. lord mayor, you know the importance of learning, and the chancellor has emphasised again this evening the role of education in shaping britain ’ s place in the world economy. both the chancellor and i have been enthusiastic about the theme of your mayoralty : “ city of london – city of learning ”. and all of us here tonight would like to pay tribute to your work since you became lord mayor, and to thank both the lady mayoress and yourself for the splendid hospitality which you have extended to us all this evening. so i invite you all to rise and join me in the traditional toast of good health and prosperity to " the lord mayor and the lady mayoress ".