It means being ready temporarily to raise regulatory requirements above their minimum level when risks from the economic and financial environment exceed anything remotely calibrated into the standards that apply in broadly normal conditions. And it means promptly relaxing those extra requirements once the risk to stability has passed. This is a massive step. No one is pretending that the policy community knows how to cast it in terms of a numerical target or a uniquely useful set of indicators, against which society can monitor us. And that underlines the importance of Parliament itself approving the instruments granted to the FPC, and of our being sufficiently transparent to enable public scrutiny of and debate about our analysis and policy decisions. The Bank/FSA Discussion Paper on macroprudential instruments published last December was a contribution to that.25 Back to current account imbalances: they do matter But that is not all that we, policymakers, should be modest about. If, as I believe, macroprudential policy can prospectively fill a gap, we must not pretend that it can be a cure for everything. Even if we had avoided the worst consequences of seriously suboptimal gross capital flows – a badly overlevered banking system dependent on flighty wholesale funding – there would still have been the problem of unsustainable global current account imbalances. Whether the eventual adjustment would have been disorderly and how costly is hard to tell.
Previous empirical work examining the falls in US and UK long-term interest rates over the 2004–2006 period foundfalls in term premia to have played the dominant role.27 Those studies put forward two possible explanations for their finding: lower perceptions of macroeconomic uncertainty or an effect from a “search for yield” in a low interest rate environment. The correlation found here between changes in short interest rate and distant real forward rates suggest that the possibility that monetary policy can affect risk premia should be taken seriously. 27  See Joyce et al (2011), “Understanding the Real Rate Conundrum: An Application of No-Arbitrage Models to the UK Real Yield Curve” and Backus and Wright (2007), “Cracking the Conundrum”. BIS central bankers’ speeches  19