keep sole responsibility for the conduct of monetary policy, retaining its independence. there are important reasons for this approach. one is that systemic risk surveillance will benefit from the perspectives of regulators with different windows on the financial system, all participating in the oversight council. second, the principle of central bank independence in the conduct of monetary policy is widely accepted as vital to achieving maximum employment and price stability. fortunately, it is perfectly possible to attain good outcomes even if monetary policy and macroprudential policy are carried out separately and independently, and the goals of each are pursued using entirely separate tool kits. this conclusion is an application of the assignment problem made familiar by robert mundell and others who analyzed monetary and fiscal policy. 18 a key insight from that literature is that satisfactory results can be attained without policy coordination, even though fully optimal policy generally calls for coordination when spillovers occur. of course, it is necessary for monetary policy to take into account any macroeconomic effects resulting from macroprudential policy and vice versa. this separate - assignments approach to formulating macroprudential and monetary policy has merit both in theory and practice. but i want to be careful not to push the argument for separation too far. i noted, for example, that situations may arise in which the federal reserve, in its conduct of monetary policy, might not be able to fully offset the macroeconomic effects of macroprudential interventions. this scenario could happen because of the zero bound on interest rates or monetary policy lags. in such circumstances, it makes sense for macroprudential policy to take macroeconomic effects into account. by the same token, i would not want to argue that it is never appropriate for monetary policy to take into account its potential effect on financial stability. regulation is imperfect. financial imbalances may emerge even if we strengthen macroprudential oversight and control. some day in the future, it is possible that macroprudential regulators might let down their guard. in such situations, if emerging threats to financial stability become evident, monetary policy could be faced with difficult tradeoffs. my hope is that such situations will remain largely theoretical and, in practice, be exceedingly rare. overall, i am encouraged by the progress we are making in developing the new regulatory framework. still, macroprudential supervision is a work in progress, and we must humbly recognize that we have a lot to learn. see bean and others, “ monetary policy after the fall ”, in note 15, for

systems ultimately rest. over the past 70 years, financial markets have worked on the assumption that public debt in advanced economies was, indeed, risk - free. that basis has now been shaken, both by psi in europe and the debate on the debt ceiling in the us. we used to think of public debt in major countries as a riskless asset. not anymore, or at least not to the same extent. the immediate effects seem benign so far in the us, which remains the deepest and most liquid bond market in the world. in europe, by contrast, there have been more dramatic consequences. once credit risk has entered into sovereign bonds, a fundamental element of instability has been introduced. this is why, unfortunately, the strong statement made in the communique of the euro area heads of 21st july that greece was a unique and exceptional case did not impact the market and was followed by an increase in sovereign spreads for all peripheral countries. a second, more recent, decision may have contributed to intensifying the current turmoil. it was rightly decided by european regulators, under the auspices of the european banking authority, that banks should hold more capital to face increased uncertainty in the current environment. a deadline was set for them to achieve a 9 % core tier 1 ratio, based on a commonly agreed definition of capital. unfortunately, however, calibration for this exercise explicitly incorporated a mark to market assessment of each bank ’ s exposure to sovereign debt. although this element of the calibration was deemed to have been done once and for all, just for the purpose of calculating an additional capital cushion above the objective of 9 %, the market considered the risk that it might be repeated in other circumstances. this created a powerful disincentive to hold, let alone acquire, such debt, since banks felt they could be penalized in the future. banks are major actors on the sovereign bond markets and it is certainly no coincidence that liquidity dried up and spreads went up in most markets in the days following that decision. policy responses cumulative and destabilizing dynamics need to be addressed by a conjunction of complementary actions. first, it is essential to stabilize european bond markets. we have to recognize that the necessary degree of fiscal adjustment is heavily dependent on the level of market confidence. this has been well recognized by france with the recent eur 18 billion consolidation package for this year and 2012, consisting notably of tax benefit reductions, vat increases and an acceleration of the pension reform. but we also know