indeed significant benefits. 2 policies characterized by commitment have been shown to lead to more economic stability – lower and less volatile inflation and less volatile output. in fact, the mainstream theoretical finn e. kydland and edward c. prescott, “ rules rather than discretion : the inconsistency of optimal plans, ” journal of political economy, 85 ( june 1977 ), pp. 473 – 91. for an excellent overview, see richard clarida, jordi gali, and mark gertler, “ the science of monetary policy, ” journal of economic literature ( december 1999 ), pp. 1661 – 1707. bis central bankers ’ speeches models that we use for monetary and macroeconomic analysis are built on the notion that monetary policy is conducted in a rule - like manner. the practice the practice part of the session title has proven to be a bit more elusive. the science of monetary policy has not progressed to the point where we can specify the optimal rule for setting monetary policy. the reason is that optimal rules, that is, those that maximize economic welfare, are highly dependent on the particular model from which they are derived, and there is no broad - based consensus for the right model. more relevant is the finding that the optimal rule for one model can produce very bad outcomes in another model. in addition, optimal rules can often be quite complex, thus making them difficult to implement and to communicate to the public. in other words, they may not be very transparent. however, these limitations to implementing optimal policy rules should not deter us from efforts to adopt a more systematic rule - like approach to the conduct of policy. there has been a great deal of progress made in identifying simple rules that appear to perform well in a variety of models and environments. such robust rules can form a basis for developing more systematic, rule - like policymaking. one important and desirable characteristic of a systematic and rule - like approach to policy relates to communication. in particular, it is an approach that is easily communicated to the public and thus greatly improves the transparency and predictability of monetary policy, which reduces surprises. the public and markets are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances. equally important in my view is that greater clarity about the policymakers ’ reaction function strengthens accountability and thus can serve to preserve the central bank ’ s independence. the most well - known simple rule, of course, is the one proposed by john taylor in

##ute existing shareholders. another way markets can aid supervision is through the information they can provide to supervisors. markets aggregate many risk assessments into a single measure, such as the price or quantity traded of a security. these market measures can be compared across institutions to provide an indication of relative risk. the measures can also be monitored over time to provide indications of changes in risk. market participants have strong financial incentives to correctly price a firm ’ s risk. since market prices of securities tend to be forwardlooking, they reflect investors ’ expectations given the current information. there are several examples of how market signals could be incorporated into the regulatory process. for instance, if financial firms were required to issue subordinated debt, as i have just discussed, supervisors could monitor a bank ’ s subordinated debt spreads for indications of emerging risk and take appropriate actions in response. this strategy is supported by evidence that subordinated debt spreads do increase with the risk profile of the issuers. others have argued for using credit default swap spreads or market - based capital measures in the supervisory process. in particular, the federal reserve has proposed using market signals in establishing thresholds for “ early remediation ” under the dodd - frank act. the argument for greater use of market data in bank supervision is not that market signals are always superior to supervisory assessments, but that market data can complement information gathered by examiners. there is still much to learn about how best to combine market data with examiner data to improve supervisory assessments of risk in the financial system, and additional research in this area could prove highly useful. bis central bankers ’ speeches of course, if we want to effectively leverage market discipline, then we have to address the problem of too big to fail. if creditors perceive they will be rescued, then market discipline is undermined and moral hazard will lead to greater risk - taking by the institutions. it is important to recognize that the moral hazard problem is not mitigated by eliminating the potential for government support. it doesn ’ t matter where the money comes from to rescue creditors. any means of providing an implicit or explicit subsidy to protect creditors undermines market discipline and creates moral hazard. without an effective and credible resolution regime that ensures no subsidies to creditors, there is less incentive for markets to monitor a firm ’ s risk – thus, the firm ’ s risk would not be accurately reflected in security prices. title ii of the dodd - frank act expanded the existing authority of the federal deposit insurance corporation ( fdic ) to resolve failing banks