We do not have zero appetite for failure of individual firms, provided that they do so in an orderly way that does not impose large costs or disruption on policyholders – neither in the form of direct losses nor of disruption – does not have knock on effects elsewhere in the financial system, and there is sufficient capacity elsewhere to substitute for the loss of the failing firm. We cannot leave this all to the market. Intervention in the form of prudential regulation is necessary because of the inverted production cycle in insurance – policies pay out after, in many cases long after, they are taken out – because of the limited or non-existent ability of many policyholders to monitor or react to increases in risk taking by their insurer during the life of their policy, and because of the incentive for managers and limited liability shareholders to increase risk if their capital stake drops too low – so called gambling for resurrection. These market failures are addressed not just by capital requirements, but by the interplay between capital and the other two pillars of the regime. Goldilocks and the three pillars: how much capital is just right? ‐ speech by Anna Sweeney | Bank of England  Page 3  Pillar 3: market discipline Pillar 3 is disclosure of information about a firm’s balance sheet risks. Market discipline is not wholly absent from the insurance sector either at the inception of or during the course of policies.
The unemployment rate fell by around 2 percentage points in the post-independence period. Its standard deviation was cut in half. And fifteen years of sustained economic growth followed. Table 1: Inflation lower and less volatile since MPC independence Annual CPI inflation  Inflation volatility  Four-quarter GDP growth  Four-quarter GDP growth volatility  Unemployment rate  Real wage growth  Pre-inflation targeting (1972-1992)  9.0  5.4  2.2  2.9  7.8  0.8  Start of inflation targeting to MPC independence (1993- 1997Q2)  2.3  0.4  2.9  0.7  9.0  0.3  MPC independence to crisis (1997Q3 - 2007)  1.6  0.5  3.0  0.9  5.4  0.7  2008 - end 2012  3.3  1.0  0.0  2.7  7.4  -0.3  2013 - present  1.7  1.0  2.0  0.5  5.2  0.2  However, with time, the initially healthy focus on price stability became a dangerous distraction. Against this serene backdrop of “the Great Moderation”, a storm was brewing. 3 This is the time-consistent optimal policy in the textbook New-Keynesian model with purely forward-looking IS and  Phillips curves. See Clarida, R, Gali, J and Gertler, M (1999), “The Science of Monetary Policy: A New Keynesian Perspective”, Journal of Economic Literature, December.