8  BIS Review 125/2010  Giavazzi and Giovannini 12 have recently described this hazard as a “trap”, which ultimately arises from an asymmetric response of monetary policy to liquidity conditions: benign neglect during the build-up of liquidity risk, and forceful interventions during a liquidity crisis.
They conclude that monetary policy can avoid this situation by setting the interest rate at a higher level than the one suggested by macroeconomic conditions, as measured by standard indicators. In particular, they recommend following a Taylor rule appropriately modified to counteract excessive liquidity transformation by the financial sector. They do not discuss however how to make this prescription operational.