The time-inconsistency problem that pervades the debate over the balance between rules and discretion in monetary policy (Kydland and Prescott (1977), Barro and Gordon (1983)) is arguably even more acute for prudential policy. This is partly because adverse crisis outcomes are highly non-linear and costly, making it more difficult to pre-commit to avoiding forbearance and bail-out. The low probability of crises may also mean that policymakers are insufficiently tough in tackling financial sector risks when times are good and memories of previous crises distant (Reinhart and Rogoff (2009), Malmendier and Nagel (2011), Gennaioli et al (2015)). This can create political pressures to relax regulations to support shorter-term goals. Public choice theory (Olson (1965)) would also suggest that lobbying pressure is likely to be more acute for regulatory policy than for monetary policy. The private costs of regulation are borne strongly by narrow, but 26  All speeches are available online at www.bankofengland.co.uk/speeches  26  powerful, interest groups in the financial industry. And while higher than target inflation is quickly observable, it may be very difficult to judge in real time that regulation is insufficiently stringent given the difficulties of quantifying the probability of future financial crises. These arguments point to the need for strong institutional frameworks, supported by clear mandates, objectives and instruments, to deliver financial stability policy. Indeed, on conceptual grounds, the need for such a framework appears to be at least as strong, if not stronger, than for monetary policy.
The Benefits of Higher Capital Requirements  The assumptions underpinning the marginal benefits of higher capital in the LEI study were as follows: banking crises occur, on average, once every 20-25 years; the median estimate of the cumulative discounted costs of a crisis is around 60% of annual pre-crisis GDP; each percentage point increase in the capital ratio reduces the probability of a banking crisis by a smaller amount, ranging from 1.4% to 1% (for a capital increase from 10% to 11%) to 0.4% to 0.3% (for a capital increase from 14% to 15%); and, finally, the level of bank capital has no impact on the severity of crisis. 10  All speeches are available online at www.bankofengland.co.uk/speeches  10  Since the LEI report, a rich seam of the literature has emerged on the determinants of crises and their severity (∆). Some of the most illuminating pieces of this research have drawn on evidence from a long historical time-series and across multiple countries (for example, Jordà et al (2013), Taylor (2015)). The key findings are as follows. First, credit booms are probably the single most important determinant both of the likelihood of crises and of economic performance in the recovery after them (Schularick and Taylor (2012), Jordà et al (2013)). A sustained 1 percentage point increase in the credit-to-GDP ratio raises the probability of crisis from 4% to around 4.3% per year.