question, where does this history leave us on the reserve level we should aim for today? amongst those who take an interest in these matters, there is a lively debate. i have the pleasure of going to the bank for international settlements in basel several times a year to meet and discuss with other central bankers. some continue to emphasise the case for a return to a small balance sheet. the case for ‘ renormalisation ’ puts great weight on the benefit of putting liquidity management squarely in the hands of private institutions and markets. and it points to the risk that banking system behaviours may change in undesirable ways over time the longer the central bank balance sheet remains large, for example if the level of runnable deposits in the banking system were to increase. indeed, raghuram rajan made similar points when the financial markets group hosted him for this event last year. at the bis, claudio borio has made the case particularly forcefully, setting out the principle that the central bank balance sheet should start out as small as possible, flexing up only in times of stress. others see benefits of the central bank supplying reserves relatively freely, sometimes referring to a ‘ new normal ’. jeremy stein, for example, has argued that a larger central bank balance sheet can improve financial stability by ‘ crowding out ’ excessive risk taking in the private sector. [ 10 ] such thinking is not new per se – milton friedman ’ s essays on “ the optimal quantity of money ” come to mind. what is relatively new, perhaps, is for such thinking to be adopted on a broad basis amongst the central bank community. it is part of a debate with many nuances. [ 11 ] as the federal reserve ’ s annette vissing - jørgensen has pointed out, how reserves are supplied will matter for the cost and benefits of larger central bank balance sheets. what i think is emerging as a mainstream view amongst central bankers is that we need to thread this middle path. before the financial crisis, monetary policy was implemented with a much lower level of reserves than we have today. that worked well enough for monetary policy. but as we discovered to our cost, the level of liquid assets in the system, including central bank reserves, was too low for financial stability purposes, and this contributed to the scale of the financial crisis. and much has changed in the world since the financial crisis. the demand for reserves is much larger than it was. both the deposit base and regulatory requirements have grown

– more exactly the ( mis ) interpretation of conditional as unconditional statements – in the outside world. but i think it ’ s clear enough that central banks have rarely if ever committed themselves unconditionally to future policy. it ’ s clear too that, on several occasions, the outside world has nonetheless viewed these statements as promises. i ’ ll give some examples before a short concluding section. credible, “ low - for - long ” guidance as a means of easing policy at the lower bound so let ’ s start with the value of commitment when the policy rate is close to the lower bound. as you know, the last thirty years have seen a marked decline, around the world, in the underlying, “ equilibrium ” real rate of interest ( sometimes called “ r * ” ). this a real phenomenon, not a monetary one, caused by some combination of a greater desire to save – across the world as a whole – and weaker investment demand. but central banks have still had to accommodate the decline and the appropriate nominal rate of interest has therefore fallen alongside this “ r * ” [ 7 ]. however, there ’ s a limit to how far the nominal rate can fall. as long as people also have access to physical cash, bearing zero interest, it ’ s not possible to lower the official rate much below that level. and when the “ normal ” policy rate is already close to that lower bound there ’ s very little room for conventional policy to respond to negative, disinflationary shocks. this in turn creates the potential for deflationary traps. because the policy rate can ’ t fall in response, a decline in inflation expectations pushes up real interest rates, depresses demand and inflation, and this justifies the original ( and self - perpetuating ) weakness of expectations. these traps are potentially very costly as they can lead to protracted periods of unnecessarily weak economic activity. it was in a determined effort to avoid them, having already cut interest rates as far as they could, that central banks then turned to alternative, “ unconventional ” monetary policies. for the most part this meant qe. asset purchases are designed to keep a lid on forward rates, thereby supporting demand and activity. in the academic literature, however, many economists argued for an alternative – and potentially more powerful – option, namely a committed form of forward guidance. the economist michael woodford has been one prominent advocate [ 8 ]. remember that the name of the game,