5 Ivashina and Scharfstein (2010) document a sharp contraction in new loans to large borrowers during the peak of the financial crisis with a 47% quarter-on-quarter fall from Q3-Q4 2008. 6 Brooke et al (2015). 7 Haldane (2013) for instance argues that “We need to build defences to protect against the collateral damage from financial flood. We need to be popping, not mopping”. 8 Consistent with that, the FPC is not authorised to take actions that would “have a significant adverse effect on the capacity of the financial sector to contribute to the growth of the UK economy in the medium or long term”, Financial Services Act (2012), Section 9C; see http://www.legislation.gov.uk/ukpga/2012/21/pdfs/ukpga_20120021_en.pdf. 9 The Bank of England published a staff paper in 2015 that sets out a framework for measuring the macroeconomic costs and benefits of higher bank capital requirements. See Brooke et al (2015). 10 Brooke et al (2015) estimate that a1percentage point increase in risk-weighted capital ratios will result in a 10 basis point increase in lending rates. This estimate includes a partial offset due to the Modigliani Miller (1958) theorem, under which the capital structure has no impact on funding costs as more equity makes debt safer and equity less volatile, lowering the required rate of return for both. The conditions for the full offset in the theorem are unlikely to hold in practice for banks.
The real failure of economists was that too much energy was devoted to forecasting – to trying to assess whether economies would turn down – and not enough was spent analysing the question of “well, what if they do; how bad could it be?” And as a result, the financial system was unprepared. It was not a failure of economics. It was a failure to apply economics to the right question. Without economics, the answers to “how bad could it be?” relied all too often on recent historical precedent; on this time being different. 11  And, even more dangerously, they relied on market measures of risk; indicators that – as recent work at here the LSE Systemic Risk Centre shows – often point to risks being at their lowest when risks are actually at their highest. 12  The Financial Policy Committee’s mandate is to break free of the shackles of forecasting, to free us from trying to predict if the economy will turn down, and to apply economic analysis to the question of how bad it could be if it did. 13  The re-focussing of economic research since the crisis has supported us in that. It has  established, for example, how far: 14  Recessions that follow credit booms are typically deeper and longer-lasting than others ; 15  Over-indebted borrowers contract aggregate demand as they deleverage ;  While they have high levels of debt, households are vulnerable to the unexpected.