In my view it should only be a very last resort. The aim of the game should be to manage the system so that society can enjoy the gains of a flourishing financial sector – the efficient allocation of resources and transfer of risk – whilst minimising the threats to economic stability. So we need to have effective systems not just for preventing crises but for dealing with bank failures if and when they happen. The collapse of securitisation markets in August 2007 and the failure of Northern Rock revealed gaps in the UK’s arrangements, With the benefit of hindsight, the main problem was not the handling of the initial rescue – although the tripartite’s footwork may have owed more to John Sergeant than Fred Astaire. But I don’t think anyone believes now that the business could have been saved. It was in terminal difficulties and it was right to rescue it and protect depositors. The bigger problem was that, having stepped in, the authorities were hamstrung by the inadequacy of the legal powers to resolve it quickly and cleanly. We have learned from that autumn’s experience. Since then we have found imaginative ways to provide the market with the liquidity it needs (through the Special Liquidity Scheme, long term repos, and now the discount window), we led the world in recapitalising banks in the autumn and we have resolved the banks which could not survive swiftly and effectively both through private sector solutions and through the use of statutory measures.
And there will often be scope for those affected to work out ways to circumvent them, including by moving activities outside the regulatory perimeter. As Federal Reserve Board Governor Jeremy Stein has noted, monetary policy may be a blunt tool for addressing financial stability risks, but it does have the virtue that it “gets in all of the cracks”. 7 So, there may well be times when monetary policy is the only game in town to guard against incipient financial stability risks. In that case, we are back in the world where monetary policy makers need to be prepared to consciously lean against the wind by deliberately undershooting their inflation target in the near term in order to reduce the likelihood of something nastier down the road. This thinking has now been embodied in the Chancellor’s remit for the MPC, which sets our objectives each year. It notes that “circumstances may arise in which attempts to keep inflation at the inflation target could exacerbate the development of imbalances that the FPC may judge to represent a potential risk to financial stability. The FPC’s macroprudential tools are the first line of defence against such risks, but in these circumstances the MPC may wish to allow inflation to deviate from the target temporarily.” The remit also directs the MPC to have regard for the actions of the FPC and vice versa. I opened my remarks tonight by observing that my time at the Bank has neatly fallen into two halves.