In that light, it could in theory be cast as an enriched Taylor Rule, where a single policymaker “sets” both the risk-free policy rate and the credit spread on bank lending.24 This is, of course, an elegant and illuminating thought experiment. But can we do it? The “cyclical” macroprudential tools most discussed are variations of capital or liquidity or margin/haircut requirements. For now, I do not think we know enough about how they will work to control spreads and risk premia. And nor would we know precisely where we wanted to put these premia even if we could control them. This is not remotely a counsel of despair given the goal here: to choke off tail risk. Instead, I find it easier to think about the broad goals of macroprudential policy in terms of balance sheets. The regulatory reform Bill currently going through Parliament enjoins the Bank’s Financial Policy Committee to take heed of unsustainable levels of debt, leverage or credit growth, with the aim of ensuring that the financial system becomes and remains resilient. In other words, consistent with the theme of my remarks this evening, the FPC is to act upon the balance sheets of financial intermediaries, and indirectly to influence the balance sheets of other sectors of the economy. That means making judgments about incipient risk to the financial system from its own balance sheet and from borrowers.
4  Represented by, for example, Bernanke (2005), “The Global Savings Glut and the US Current Account Deficit”. 5  See King (2011), “Global imbalances: the perspective of the Bank of England”. BIS central bankers’ speeches  3  So we need richer stories to make sense of what happened. It is precisely in that spirit that colleagues at the Bank for International Settlements6 have stressed the importance of gross capital flows. As Cecchetti has emphasised, whereas global current account balances (the counterpart of net capital flows) expanded in the twenty years to 2007 from about 1% of world GDP to about 3%, the gross capital outflows of all countries increased from around 3% to over 15% of world GDP (Chart 5). And the aggregate international investment position of all countries7 increased from under 50% to over 150% of annual world GDP. Opening up the possibility that gross capital flows matter transforms the picture. For example, as Borio points out, Europe’s gross capital flows were enormous, accounting for around half of gross inflows into the US in the run up to the crisis. And sufficient of that was invested in US ABS for the US’s mortgage crisis to be transmitted across the Atlantic, including to France and Germany, pretty well instantly in 2007 – and before the solvency of the banking system was in doubt. Even if gross and net flows had been equal, wouldn’t the composition of those flows have made a difference?