The second observation is that by encouraging the use of responsible liquidity management, source countries can reduce the probability of a sudden rush for the exit. The FSB’s recent proposals to reduce structural vulnerabilities from asset managers are an excellent example of this. Recommendations to enhance reporting to authorities, undertake more stress testing and to extend the suite of liquidity management tools available to fund managers will all help better align investors’ expectations of liquidity with reality, and hence ensure their flows to the rest of the world are less flighty and more sustainable. Conclusion  Thus far I have focussed on the idea that acting in our own local interest to build up domestic resilience helps protect us from global forces that we cannot control on our own. Let me end with a word on the benefits and limitations of working together. 15  Details of the modelling and assumptions used are set out in Technical Appendix 2: Model of monetary-macroprudential policy coordination with market-based finance. 7  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  7  There are many ways in which co-operation on macro-prudential policies could be deepened further. Options which could warrant further investigation range from formalising the exchange of information, to frameworks for reciprocity for tools beyond the countercyclical capital buffer, to common stress test scenarios and risk assessment that are used across the world.
Such a short-term supply cost could come about if higher spreads affect the relative price of different factors of production, for example by increasing the cost of capital and depressing investment. 16  We rely on five-year averages given we look at the sum of coefficients of five lags of ∆Cred* Following Ajello et al (2016), private sector agents’ expectations of period 2, denoted by 𝐸1𝑃𝑆 , depart from full-information rational expectations, which would lead them to cut back spending when credit was growing quickly and a crisis became more likely. Their expectations instead treat the crisis probability as fixed and negligibly small. See Ajello et al (2016) for more details. 17  10  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  10  Credit spreads are affected by the setting of the CCyB (𝑘1 ): when banks are required to use a greater proportion of more expensive equity, this raises their weighted average cost of funding, leading them to increase the spread between lending rates and the policy rate. The benefit of using the CCyB is that it reduces the probability of a banking sector crisis (𝛾1𝐵 )  18  via two channels: first, activating the CCyB can ‘lean’  against a build-up in banking sector credit growth (𝐵1𝐵 ), since (𝜙𝑠𝐵 < 0 and ℎ𝐵 > 0); and second, for a given level of credit growth, a higher CCyB directly reduces the probability of a crisis due to the resilience benefits of higher bank equity capital (ℎ𝑘 < 0).