on risk - taking behaviour, as low volatility encouraged an underestimation of the likelihood and severity of adverse tail risks crystallising. seen in this light, the great moderation sowed the seeds of its own destruction. on top of this, of course, there was a litany of microeconomic features that aggravated the crisis, including : the development of complex securities that were impossible to value in stressed conditions and connected financial institutions in unexpected ways ; disguised leverage through the use of securitisation vehicles, whose primary aim was regulatory arbitrage ; remuneration packages encouraging positions that generated decent returns most of the time but high losses in some states of the world ; excessive reliance on credit - rating agencies ; defective risk management ; weak funding structures ; and insufficient high - quality bank capital to absorb losses. that said, the experience of the past few years does appear to suggest that monetary policy ought to take greater account of financial stability concerns. ahead of the crisis, bill white and colleagues at the bank for international settlements consistently argued that when leverage was becoming excessive and / or asset prices misaligned, central bankers ought to “ lean against the wind ” by keeping interest rates higher than necessary to meet the price stability objective in the short run. 3 just as central banks are willing to accept temporary deviations from their inflation targets to limit output volatility, so they should also be willing to accept temporary deviations to attenuate the credit cycle. essentially it is worth accepting a little more volatility in output and inflation in the short run if one can thereby reduce the size or frequency of asset - price busts and credit crunches. such a view ran counter to that espoused by many central bankers, most notably federal reserve chairman alan greenspan, who questioned the feasibility of addressing such financial imbalances with preemptive monetary policy ; in his view, monetary policy should instead focus on minimising the fallout from any subsequent correction – the so - called “ cleaning ” approach. 4 while the logic of leaning against the wind is sound in principle, the key question is whether a monetary tightening of plausible magnitude is likely to be effective in attenuating an established credit boom. even if policy rates may appear with hindsight to have been held too low for too long in the years preceding the crisis, particularly in the united states, the empirical evidence suggests that they would need to have been significantly higher to have had a meaningful impact on the rate of credit expansion.

contained in our quarterly inflation report. last august, however, the mpc decided that more explicit guidance about our reaction function could be helpful. rather than aiming to provide more stimulus as in the academic literature, we were merely seeking to ensure that the recovery was not nipped in the bud by a premature rise in market interest rates, despite there still being a significant margin of economic slack. we said then that we would not even countenance a rise in bank rate until unemployment had fallen to 7 %, subject to overrides relating to excessive upward movements in inflation expectations and to the risks to financial stability, the latter being policed by the financial policy committee. we chose unemployment in part because its behaviour is directly linked to one of the key uncertainties at the current juncture, namely the scope for a recovery in productivity. this has been unusually weak since the onset of the crisis for reasons we do not yet fully understand ( chart 2 ). if productivity rebounded, then unemployment would fall slowly. but in that case, there would also be more scope to maintain an expansionary policy before inflationary pressures began to rise. the opposite holds if productivity growth remains weak : unemployment falls more quickly, but we would then also need to begin raising bank rate earlier. shorter - term market interest rates have moved higher since guidance was introduced, but no more so than is justified by a string of unexpectedly strong activity indicators. and there is persuasive survey evidence that businesses have both understood the message ( chart 3 ), and that it has made them more prepared to hire and invest ( chart 4 ). in the event, though, unemployment fell rather faster than expected, reaching the 7 % threshold in the data release for the three months to february. in anticipation of that, in our february inflation report, we provided further guidance, not only on the conditions that would lead the committee to begin tightening, but also the likely trajectory thereafter. regarding the first question, while unemployment provides a useful conditioning variable for not tightening, the decision of when to tighten needs to take account of other margins of slack as well. these can arise in both the labour market – for instance, discouraged workers temporarily out of the labour force and those who are underemployed – and inside firms. the amount of slack in an economy is necessarily a fuzzy concept, as potential output cannot be observed and can be inferred only indirectly. nevertheless, given the transmission lags, monetary policy makers cannot avoid forming a judgement about