Conceivably, too, such a failure could have such serious consequences for the liquidity of - or price level in some particular sector of the financial markets, that concerns would arise for the liquidity, or solvency, of other bank or non-bank institutions that were known, or believed, to be heavily exposed to that market. In this sense size does matter - and, whether or not one chooses to describe the risk of this happening as systemic, there is no doubt that a sufficiently large disturbance originating in the non-banking activity of one financial institution could put others in difficulty. This possibility must be of concern to financial regulators, including central banks, concerned with the stability of the financial system as a whole. It certainly in my view provides macro-prudential justification for regulatory oversight of the activity of (large) non-bank financial institutions, and of the non-banking activities of banks - quite apart from micro-prudential regulation in the interests of consumer protection. It provides justification, too, for some form of consolidated prudential oversight of multifunctional financial groups and for monitoring large exposures, both intra-group and to outside counterparties. Where a problem of this sort does arise, it may well justify technical central bank intervention to help contain it - for example by facilitating payments and settlements to minimise market disturbance.
They only move the time-consistency issue one step back - the policy rule may be abandoned, the central banker fired, the contract reinterpreted or rewritten.3 The other approach says that real central bankers do not and need not worry about time-inconsistency; they “just do it”, (Bennett McCallum, 1995). Central bankers should simply resist the temptation to deviate from the time-inconsistent policy, and private agents will eventually come to accept that resolve. Attractive as such a solution may appear to central bankers, it fails to answer the challenge posed by the game-theoretic result of Kydland and Prescott. And it fails to explain why it is that some countries in some periods just do it and others do not. Central bankers who have the determination and strength of purpose to “take the punch bowl away just when the party is getting going”, in McChesney Martin’s memorable phrase, clearly have the “right stuff” - so why don’t they “just do it”? 4 A deeper explanation of how this problem can be overcome requires an analysis of what might be called the “technology of collective decisions”. Individual agents can make contracts because they believe that the legal system is external to both parties to the contract. But it is difficult to write contracts that commit future collective behaviour. Collectively, we can either meet our previous commitments or we can ignore them.