This is no easy task, because the future cost is unknown and far away, while an ongoing financial market crisis is a clear and present danger. Recent events have clearly shown that moral hazard is not just a textbook phenomenon, but is in fact a serious problem. Market players do indeed rely on the implicit insurance granted by central banks and other authorities, and central banks and authorities, having no choice, do indeed step in to support markets in a crisis. There is no easy way to address the moral hazard problem. However, the right time to tackle it is probably not primarily during a financial crisis, but during the preceding calm. Since a strict declaration of no intervention by a central bank may not be fully credible, regulation must aim to neutralise the distortion of incentives which financial market participants face because of moral hazard. Larger capital and liquidity requirements are probably a robust means of countering that distortion. Larger capital and liquidity requirements do not eliminate moral hazard, but they limit the risk of an accident and thus the cost to the public in the event of a rescue. Related to the moral hazard issue is also the issue of the risk-bearing capacity of a central bank. A central bank can only act as a lender of last resort if it has the means to act as one. This is especially important if the banking system has relatively large liabilities in foreign currency.
While in many other countries the policy rate is an overnight rate, the SNB has an operating target for the 3month Swiss franc LIBOR (London Interbank Offered Rate). Without going into detail, I would like to stress two important points with respect to the transmission from the monetary policy instrument to the economy. First, monetary policy works primarily through financial markets. By setting the policy rate, monetary policy affects exchange rates, interest rates, risk premia and asset prices in general, and is thus  1  This is due, first, to uncertainties about the current state of the economy and its future evolution, and second, to long and variable lags in the transmission from monetary policy to the real economy. Therefore, monetary policy can and should only react to large and persistent deviations from equilibrium. Attempts at fine-tuning the economic cycle may even be counterproductive, in that they are procyclical. 2  Obviously, central banks also have some long-term influence on financial stability, first because of moral hazard induced by actual or expected central bank action, second, by affecting asset prices, and third, due to the involvement of central banks in banking regulation and banking supervision. Furthermore, one can also argue that price stability and economic stability are also conducive to financial stability. 3  To the best of my knowledge, this idea was first put forward by J. Niehans (1978), The Theory of Money, chapter 12, and was designated the “three frequency approach to monetary policy”.