better policy can take some credit for this improvement, as the anchoring of inflation expectations led to a huge reduction in inflation volatility. it was tempting to think that we had moved onto the “ taylor frontier ” – which maps feasible combinations of the smallest variances of the output gap and inflation. the great stability appeared to be a permanent break from earlier periods – periods when monetary policy exhibited more unpredictable behaviour and left the economy to the north - east of the taylor frontier ( chart 2 ). and in one important sense it was – the dark days of double - digit inflation were consigned to the past. the inflation measure used is the quarterly rate of increase of the gdp deflator, defined as the ratio of nominal gdp to real gdp. the output gap is estimated as the difference between the log of real gdp and the trend path of log gdp, derived using the hp - filter. source : ons and bank of england calculations. bis central bankers ’ speeches but the great stability was not representative of a new normal. the variance of the output gap – though not inflation – has been much higher over the past five years as the financial crisis generated a deep recession ( chart 3 ). so what have we learned? the banking and broader economic crisis has demonstrated that macroeconomic policy can face an additional trade - off between ensuring the soundness of the financial system in the medium term, and keeping output in line with potential output and inflation on target in the near term. such a trade - off arises because financial vulnerabilities can build even while output is growing steadily and inflation is low and stable. let me give three examples of the sort of underlying mechanisms at play. first, persistent misperceptions of future spending power may generate a mix of demand that proves to be unsustainable. i believe this was an important factor underlying the crisis. although output in deficit countries – like the uk – appeared to be growing at a sustainable rate, that gave a misleading impression of the sustainability of the great stability. in fact the level of domestic demand was too high and the level of net exports correspondingly too weak. second, as hyman minsky described, periods of stability encourage exuberance in credit markets, leading eventually to instability. and third, low short - term policy rates may encourage investors to take on more risk than they would otherwise accept as they “ search for yield ”. it is arguable that monetary policy paid insufficient heed to the potential impact of such

in the real equilibrium of the economy. i do not believe that the present problems in the united kingdom stem only from a large negative shock to aggregate demand. in common with many other countries, our problems also reflect the underlying need to rebalance our economy, requiring a reallocation of resources both within and between nations. it is not simply a question of boosting aggregate demand, but of helping to bring about a shift to a new equilibrium. that in turn implies the need for both large changes in relative prices, especially between tradable and non - tradable goods and services, and a shift in the relative levels of domestic demand at home and overseas. there are, therefore, limits on what any one country ’ s domestic monetary policies can achieve without the support of others. despite these limits, circumstances have demanded that central banks take extraordinary measures. such measures can risk moving into territory more normally associated with fiscal policy and, in doing so, put at risk their hard - won independence. there are, it seems to me, three threats to central bank independence. first, there is the risk of appearing to promise too much or allowing too much to be expected of us. with constraints on other policy instruments, central banks are seen as “ the only game facilities introduced by the bank of england have included the discount window facility, the special liquidity scheme, extended collateral term repos, extended collateral long term repos, and the funding for lending scheme. the ecb initiated its long term repo operations. and federal reserve facilities include the term auction facility, the term assert backed securities loan facility, the primary dealer credit facility, the commercial paper funding facility, the term securities lending facility, the abcp money market fund liquidity facility, the money market investing funding facility, and the term discount window program. bis central bankers ’ speeches in town ”. but failure to make clear the limits to monetary policy risks disillusionment with central banks and the inevitable political pressure on them that would follow. second, at the zero lower bound there is no clear distinction between monetary and fiscal policy. but it is still important to ensure that central banks do not take on to their balance sheets risks to the taxpayer that are properly matters that should be decided by elected politicians. to ensure price stability in the long run it is vital to maintain the operational independence of a central bank. any decisions that put taxpayers ’ money at risk must be made by finance ministries, and central banks must protect their balance sheets by imposing