and output from trend, using the bank ’ s forecasting model, compass, to simulate the effect of alternative policy paths. 20 what would it suggest was the optimal policy path given these preferences and the projections in the february inflation report? this is shown in chart 29. with the lower bound set at zero, the optimal path for interest rates would involve them being cut in the short - run towards zero for around a year, before then roughly following the market yield curve. this results in inflation and output returning to target sooner than in the february inflation report, at the cost of a slight over - shoot thereafter. even without any asymmetry in risks to the inflation outlook, a case can be made for policy easing today. the algorithm also puts some weight on smoothing of the interest rate path. for more information on compass, see burgess et al ( 2013 ). bis central bankers ’ speeches chart 29 : simulation of bank rate and cpi inflation path for bank rate cpi inflation per cent 1. 5 per cent 2. 5 1. 5 0. 5 - 0. 5 0. 5 february ir simulation with a lower bound at 0 % simulation with a lower bound at 0. 5 % february ir simulation with a lower bound at 0 % simulation with a lower bound at 0. 5 % source : ons and bank calculations. simulations show optimal policy under full commitment. were downside risks to inflation to materialise, this case is strengthened. chart 30 shows the optimal policy paths if we assume the starting level of slack is larger in line with chart 18. the interest rate path now implies that rates should be cut and held at their lower bound for longer. this alternative policy path returns output and inflation to target sooner, at the cost of a more significant over - shoot. chart 30 : simulation of bank rate and cpi inflation, if the starting level of slack is 2 % path for bank rate per cent 1. 5 per cent cpi inflation 2. 5 1. 5 0. 5 0. 5 - 0. 5 february ir simulation with a lower bound at 0 % simulation with a lower bound at 0. 5 % february ir simulation with a lower bound at 0 % simulation with a lower bound at 0. 5 % source : ons and bank calculations. simulations show optimal policy under full commitment. of course, there are good reasons why monetary policy is not set by algorithm. these simulations ignore a number of important practical uncertainties. for example, they assume that this policy path is fully credible and effective

##ntial supervision. the system - wide counter - cyclical buffer will be the responsibility of macroprudential policy. bis central bankers ’ speeches those objectives are themselves generally mutually reinforcing. while ensuring the safety and soundness of individual institutions is not sufficient for systemic stability, it surely helps. 13 meanwhile macroprudential policy seeks to reduce systemic risks and in doing so is likely to improve the resilience of individual firms. 14 at times there may be a conflict. this is most likely to arise at a turning point in the cycle when macroprudential policy – perhaps in pursuit of its secondary objective to support growth and employment – may mandate a loosening of capital requirements in order to support credit supply and broader economic conditions. a microprudential supervisor at the same time may understandably be more concerned to maintain large capital buffers. the question best answered in a single institution is which dominates – risks from a paradox of thrift or those from weakened institutions? the obvious overlaps in tools and objectives mean that combining the two arms of prudential policy in one organisation makes sense. that will also help to share knowledge and expertise, and to help avoid conflicting messages to firms. and, to the extent conflicts occur, they are likely to best be resolved within a single institution through shared analysis and mutual understanding of reaction functions. 15 our strategy will be to conduct supervision as an integrated part of the central bank and not as a standalone supervisory agency that happens to be attached to a central bank. the benefits that close cooperation can bring were demonstrated in 2013 as the pra and the fpc worked closely together to bring clarity both to banks ’ existing capital positions, and the standards expected of them. the fpc mandated the exercise with a view to establishing a system - wide, transparent standard of resilience that would boost confidence and allow the banking system to contribute to economic recovery. the pra – under andrew bailey ’ s leadership – delivered the recommendation for each of the major institutions. the resulting increase in capital ensured the core of the financial system was on a sound footing and made an important contribution to securing economic recovery. there were clearly lessons to learn from that exercise, most notably the importance of clarity of early communication by the bank to financial institutions about the standards to which they would be held. those lessons are being applied now in the first of the bank ’ s annual stresstesting exercises, which will bring together the microprudential standards for banks with a macroprudential