same time, though, the variety of possible combinations of macro - prudential instruments also makes the implementation of macro - prudential policy a complex endeavour, which has to take into account interactions, leakages and waterbed effects. going forward, analytical frameworks also need to take these elements into account. macro - prudential policy : implementation issues and effectiveness it is worthwhile to group macro - prudential policies into two categories according to the way they operate. a simple distinction can be made between measures that act through cost - price incentives, like capital requirements, and those that depend on quantitative limits, like large exposures or ltv / dtis limits. capital based instruments act to restrain the boom as long as banks ’ overall cost of funds is sensitive to the structure of its liabilities. we know since countries with more credit booms also experienced more crises ( on average ), there seems to be a trade - off between macroeconomic performance and stability ( ranciere, tornell, and westermann, 2008 ). alessi, l. and detken, c. ( 2014 ), “ identifying excessive credit growth and leverage ”, mimeo. alessi et. al. ( 2014 ), “ comparing different early warning systems : results from a horse race competition among members of the mars network ”, mimeo. gregory, d., kapadia, k., nyman, r., smith, r. and tuckett, d. ( 2014 ) “ news and narratives in financial systems : exploiting big data for systemic risk assessment ”, mimeo. bis central bankers ’ speeches that as long as cost of equity is not too high and not too insensitive to the riskiness of equity itself, this condition will not hold. higher capital requirements will increase banks ’ resilience but may add little to the cost of loans. in an environment of exuberant expectations of house price appreciation, such measures may therefore do little to restrain excessive credit demand. quantitative limits such as the ltv / dti ratio are cruder and therefore more likely to work as long as there are many borrowers who will be affected by them. i will discuss these two types of measures in turn. capital - based instruments in the basel iii framework, the ccb is the main counter - cyclical tool. it is designed to increase banks ’ resilience by making them set aside capital in good times and draw it down in bad times. if

##ous outcome – a man - made construct – and the job of macro - prudential policy is to try to smoothen this cycle as much as possible. beyond increasing the resilience of the system, i will argue that macro - prudential policy should be ambitious in leaning against imbalances and if so, it has to be prepared to be bold and intrusive. decisions on the timing, design and calibration of interventions need to be underpinned by robust analysis. while monetary policy should not be employed to smoothen the credit cycle, under the principle of “ one objective, one tool ”, the macro - prudential policy function should rest under the responsibility of central banks given synergies and the interactions between the two policy functions. this reflects the macro - prudential policy framework adopted for the ecb / ssm. the nature of systemic risk and the objectives of macro - prudential policy macro - prudential policies aim to maintain the stability of the financial system as a whole through containing systemic risks. systemic risks can be defined as risks that, if materialised, have the potential to make financial instability become so widespread that the functioning of the financial system is impaired to an extent that growth and welfare suffer materially ( ecb 2009 ). ecb staff, combining available literature and practical experiences, has developed a conceptual framework that relies on three mechanisms that can lead to systemic financial instability : risk coming from large aggregate shocks, contagion risk, and bis central bankers ’ speeches the risk from the unravelling of widespread financial imbalances that have built up endogenously over time. 1 contagion occurs when the failure of one institution “ infects ” other hitherto “ healthy ” institutions. prominent recent examples of the materialisation of contagion risk include the drying up of interbank funding following the collapse of lehman brothers. large aggregate shocks have always been an important source of widespread financial instability through history. gorton ( 1988 ) documented how negative economic news were the best leading indicators of the likelihood of banking panics in 19th century usa. the third, and, in my view, most important source of systemic risk is the risk of the unravelling of financial imbalances. these imbalances may build up gradually, mostly endogenously, and can then unravel abruptly. they form part of the inherent pro - cyclicality of the financial system. 2 it is crucial to recognise that the financial