This occurs because all firms assume a worst-case scenario – that they will be unable to access liquidity when required – and this causes them to hoard liquidity. Alternatively when information is dispersed across a large number of people, each with a noisy signal about economic fundamentals, outcomes may be determined by an “information cascade”, the outcome of which is hard to predict (Banerjee, 1992; Bikhchandani et al, 1992). 5  See May and Arinaminpathy (2010) for a model of the financial system which makes this distinction. 4  BIS Review 36/2010  There is strong experimental evidence that people are subject to biases when collecting and processing information under uncertainty, and that such processing occurs only intermittently. 6 The evidence suggests that people are also frequently incoherent in assessing, assigning and processing probabilities – even in highly artificial settings where information is complete – and find it particularly difficult to assess probabilities which are very low or very high, partly because there is less scope for learning in these cases. There is also evidence that, when making complex decisions or without full information, such as when deciding whether to have eye surgery, people often use rough heuristics, or go on first impressions, appearances, gut instinct or intuition. We want to highlight four main aspects of the behavioural view: (i)  Perceptions of risk have been shown to be unduly influenced by recent or personal experience.
But structural factors are also playing a role: higher import volumes as a result of advanced globalisation have increased the importance of international prices relative to domestic prices, forcing domestic mark-ups to be less sensitive to the state of the domestic economy. This may imply that monetary policy has to react more aggressively to counteract shocks. So in combination, central banks may be facing a two-pronged challenge to their mandates: a situation where, due to the role of global inflation, more stimulus is needed than in the past to deliver their domestic mandates; and where, due to the falling equilibrium interest rates, their ability to deliver that stimulus is more constrained. That would certainly offer one explanation for why monetary policy has needed to stay accommodative for so long across advanced economies. This does not make monetary policy ineffective. As we have seen in the euro area, even with a low equilibrium rate central banks can still steer conditions in the wider economy by targeting directly the constellation of interest rates that matter for borrowers. But one nonetheless cannot deny that the fall in the equilibrium rate poses a challenge for central banks. This challenge for monetary policy has been recognised, with a number of innovative solutions proposed by academics. Let me mention two but also say upfront that I am not particularly convinced by any of them. One option that has been mooted is to allow nominal interest rates to go deeper into negative territory.