20 Sorting out these unusual risk premia effects is crucial for conducting appropriate monetary policy and for communicating the monetary policy stance to the public and to market participants. 18  John B. Taylor, 1993, “Discretion versus Policy Rules in Practice”, Carnegie Rochester Conference Series on Public Policy 39, December, 195-214. 19  For a discussion of various types of the Taylor rule see Athanasios Orphanides, 2007, “Taylor Rules”, Finance and Economics Discussion Series 18. Federal Reserve Board. 20  Taylor, 1993, p. 198. 6  BIS Review 141/2007  3. Conclusion  Let me conclude by reiterating that much of the central banks' motivation for their involvement in financial stability is rooted in their role as providers of liquidity in general, and of emergency liquidity in particular. At the same time, it has to be recognized that central banks have a very limited arsenal of instruments to deal with crises situations. A change in the level of official target interest rate is in many ways a crude instrument that, in my view, is best deployed with a firm focus on trying to keep the economy where our statutory mandate tells us to keep it. This does not, of course, preclude a change in interest rates in the event of a crisis, but only to the extent that the risks from the crisis to the economy justify a change in policy. The current market turmoil is providing countless lessons to the industry as well as to the official sector.
As central banks, we need to consider carefully to what extent instant transparency with regard to liquidity operations may end up being counterproductive. Let me add here that this is a very complex issue. I am not arguing that the evolution towards greater transparency in central banking should be reversed. Indeed, perhaps we need greater ex ante transparency such as clearly stated conditions and eligibility criteria associated with central bank liquidity provisions. Undoubtedly, ex post transparency about potential liquidity support measures must also be guaranteed. But in the midst of a crisis, it may well be beneficial and desirable for central banks to have some flexibility with regard to how they communicate regarding potential liquidity operations. 2.2. Implications of volatile risk premia for the conduct of monetary policy  My second tentative lesson directly relates to the conduct of monetary policy. The recent market strains are unusual because confidence or rather the lack of confidence plays such an important role. Clearly, there is a great deal of uncertainty regarding valuations of complex credit instruments. Moreover and arguably more importantly, banks realize that they are facing or could face large contingent liabilities. They are therefore doing everything they can to protect their balance sheets. In essence, banks are hoarding liquidity and are reluctant to lend money in the interbank market beyond the very short term. As a result, a substantial and highly unusual risk premium has emerged in the interbank market.