a fundamental problem. banks have critical functions in a modern economy. first, banks play a key role in the payment system. in one way or another, practically all payments go through banks. individuals and firms have bank deposits that they depend on for making payments. banks operate payment systems used by shops and other businesses. they operate interbank and international payment systems and payment systems for securities trading. if payments come to a halt, the economy will seize up. second, banks extend credit : short - term trade credit and operating credit ; long - term loans for investing in housing, real estate and businesses. without this credit, businesses and investments come to a standstill. banks may be regarded as intermediaries. they channel money from depositors and other investors to borrowers. banks determine who should be given credit and monitor borrowers and their projects. moreover, they do so with considerable efficiency. thus, depositors and investors avoid having to do this job themselves. this function makes banks unique : banks extend long - term credit and raise short - term debt. 6 we call this banks ’ maturity transformation. but this transformation also makes banks vulnerable. banks are dependent on public trust. if any doubt arises as to a bank ’ s ability to service its debt, a run on the bank may ensue. depositors will then try to withdraw their funds before the bank runs out of cash and other liquid funds. the bank will in turn be forced to sell its longterm assets – its loans. this is a slow and loss - generating process. normally, a bank will fail long before it gets that far. at that time, norges bank had already injected nok 10 million in share capital as part of a new share issue totalling nok 50 million in autumn 1922 ( see rygg, nicolai ( 1950 ) norges bank i mellomkrigstiden [ norges bank in the interwar years ], p. 90 ( in norwegian ) ). ibid, p. 119. for a description of the relationship between bank lending and deposits, see mcleay et al. ( 2014 ), “ money creation in the modern economy ”, quarterly bulletin q1 2014, bank of england. bis central bankers ’ speeches until recently, such bank runs were usually associated with the great depression of the 1930s. that is, until 2007, when the uk bank northern rock failed, with long queues of depositors outside its doors. this was a forceful reminder that banks

achieve stable prices and maximum employment. moreover, those two gaps fit directly into most modern macroeconomic theories, which tell us something about their relationship and how that relationship can be affected by the type of shock hitting the economy. model uncertainties make the simplicity of the rule particularly important for the policymaker because research suggests that the prescriptions from simple rules can be more robust than optimal - control policies. optimal - control policies can depend critically on the exact specification of the model, and clearly there is no consensus about which model best describes the u. s. economy. federal reserve policymakers are shown several versions of taylor rules in the material we receive before each meeting of the federal open market committee ( fomc ). i always look at those charts and tables and ask myself whether i am comfortable with any significant deviation of my policy prescription from those of the rules. a second benefit of simple rules is that they help financial market participants form a baseline for expectations regarding the future course of monetary policy. even if the actual policy process is far more sophisticated than any simple rule could completely describe, the rule often provides a reasonably good approximation of what policymakers decide and a framework for thinking about policy actions. indeed, many financial market participants have used the taylor rule to understand u. s. monetary policy over the past fifteen years. investors and other market participants are going to form expectations about policy and act on those expectations. the more accurate and informed those expectations are, the more likely are their actions to reinforce the intended effects of policy. a third benefit is that simple rules can be helpful in the central bank's communication with the general public. such an understanding is important for the transmission mechanism of monetary policy. giving the public some sense of how the central bank sees the output and inflation gaps and how they are expected to evolve will help it understand the central bank's objectives and how policymakers are likely to respond to surprises in incoming data. four limitations of simple rules simple rules have limitations, of course, as benchmarks for monetary policy. to quote from john's carnegie rochester paper, " a policy rule can be implemented and operated more informally by policymakers who recognize the general instrument responses that underlie the policy rule, but who also recognize that operating the rule requires judgment and cannot be done by computer " ( p. 198 ). in that context, four limitations of simple rules are important. the first limitation is that the use of a taylor rule requires that a single measure of inflation be used to obtain