Global interest rates have been extraordinarily low since the Global Financial Crisis. This recession-fighting monetary policy, however, may be inflating financial bubbles. Macroprudentialism is the policy that many central banks are using to reduce the chances that today’s low-for-long rates are sowing the seeds of future crises. Macroprudentialism, however, involves a set of relatively untested policies. Things as basic as the precise objective of macroprudential frameworks and their interactions with monetary policy and microprudential supervision are still not clear.
Today, VoxEU.org launches an eBook that collects the thinking on macroprudentialism from a broad range of leading US and European economists.
Table of contents
Part I: Setting the scene
The use of macroprudential instruments
Charles A E Goodhart
Part II: System objectives
A programme for improving macroprudential regulation
Anil K Kashyap, Dimitrios P Tsomocos and Alexandros P. Vardoulakis
Macroprudential frameworks: (Too) great expectations?
Macroprudential policy and monetary policy
The political economy of macroprudential regimes
Macroprudential policy: The neglected sectors
Malou Dirks, Casper de Vries and Fieke van der Lecq
Part III: Instruments
Capital regulation and credit fluctuations
Hans Gersbach and Jean-Charles Rochet
Understanding financial cycles
Stijn Claessens, M Ayhan Kose and Marco E Terrones
Unintended consequences of macroprudential policies
A leverage ratio for the banking system: A macro instrument
The simple analytics of systemic liquidity risk regulation
Enrico Perotti and Javier Suarez
Externalities: An economic rationale for macroprudential policy
Giovanni Favara and Lev Ratnovski
Part IV: European Coordination
A macroprudential policy framework for the EU and its member states
Viral Acharya and Charles W. Calomiris
Europe’s macroprudential policy framework in light of the banking union
The authors come to a consensus on the broad objectives of macroprudential supervision, but important disagreements remain:
- Increase only the resilience of the financial system to financial shocks or also stabilise credit cycles?
- Should monetary and macroprudential policies move in tandem (reinforcing each other) or should they operate separately?
- Should the primary focus be on banking or also on securities, insurance, and pensions?
- The precise level of capital surcharges on large banks to curtail the too-big-to-fail problem.
Macroprudential supervision is the missing link in the broader monetary and financial policy framework – as the Global Crisis and subsequent Eurozone Crisis painfully pointed out. In several nations, including the US, Ireland, and Spain, spectacular rises in house prices were accompanied by unsustainable credit growth. The bursting of the US bubble triggered the largest crisis the world has seen since the Great Depression. Bursting of the Irish and Spanish bubbles threatened not just bank but also national solvency.
Central bankers and other macroeconomic policymakers stood by and watched the problems accumulate as they thought it was sufficient to conduct monetary policy and microprudential supervision. But the former is concerned only with inflation of consumer goods, ignoring inflated asset prices. And the latter is concerned only with the soundness of individual financial institutions, using internal models that are run on the assumption that risk is exogenous.
The Global and Eurozone Crises have shown that the financial system as a whole matters, and that the unravelling of risk has endogenous feedback loops, as the chapters by Claudio Borio and Anil Kashyap and co-authors point out.
New policy framework
Figure 1 shows the new policy framework and places macroprudential supervision in the middle of monetary policy and microprudential supervision. Macroprudentialism has interactions with both policy areas as the authors of the eBook point out. Macroprudential supervision operates at the level of the financial system and is concerned with the impact on the wider economy.
Central banks are returning to their roots by re-assuming a broad mandate. History teaches us that central banks have always had a dual role in maintaining price stability and financial stability, as Charles Goodhart points out in his chapter. Accordingly, financial stability departments of central banks have been, and continue to be, strengthened.
Figure 1. Policy framework for the financial and economic system
Source: Based on Schoenmaker and Wierts (2011).
What are the objectives?
There is consensus on the broad objectives of macroprudential supervision.
- With respect to the time dimension, macroprudentialism should increase the resilience of the financial system against financial shocks.
- With respect to the cross-sectional dimension, macroprudentialism aims to strengthen the structure of the financial system.
But then the disagreement sets in.
Some analysts are modest and aim just to increase the resilience of the financial system against financial shocks (the Borio chapter makes the case for this). Others would go further, preferring countercyclical policies to constrain financial booms, which are largely related to housing and property markets (as argued by Gersbach and Rochet and by Claessens, Kose and Terrones).
My take is that macroprudential supervision should – at the minimum – reduce the contribution of the financial system to the swings in the financial cycle, i.e. reining in the growth of credit and asset prices. This is exactly what Gersbach and Rochet propose as an objective – to limit the banking system’s tendency to amplify economic fluctuations.
Next, the macroprudential focus should be on the financial system rather than on individual financial institutions. While the new macroprudential toolkit – with tools such as countercyclical capital buffers and capital surcharges – is primarily aimed at the banking sector, several authors in this eBook call for going further. Paul Tucker suggests looking additionally at the shadow banking sector and securities markets. Dirks, De Vries and Van der Lecq stress the impact of financial institutions with a large asset base – such as pension funds and insurance companies – on the macroeconomy. Poorly designed micro-supervisory rules for these financial institutions may amplify the business cycle. The authors call for a macro makeover of these micro rules.
Interaction with other policies
The authors of the eBook reflect both sides of the longstanding debate on how monetary and macroprudential policies should interact. Goodhart and Tucker stress that the role of macroprudential policy is separate from that of monetary policy. Macroprudential policy takes a more granular approach by targeting particular markets or sectors, such as housing and property markets. In contrast, Borio argues that monetary and macroprudential policies work in tandem since monetary policy influences risk perceptions and risk appetite (the risk-taking channel). As Stein (2013) puts it, monetary policy is more persuasive because it ‘gets in all the cracks’ of the financial system.
Finally, there is the issue of how to strike the right balance between macro- and microprudentialism? There is an emerging consensus that macro stability should have priority over micro soundness (see the chapters by Tucker and by Dirks, De Vries and Van der Lecq). In a more reflective mode, Borio argues that macroprudentialism stands for an intellectual orientation or lens through which the task of achieving financial stability is understood. Prudential tools should be designed through a macro lens instead of the prevailing micro lens.
Two pillars of the macroprudential building
The macroprudential ‘building’ has two pillars or risk dimensions:
- The cyclical (time-series) dimension; and
- The structural (cross-sectional) dimension.
On the first, Gersbach and Rochet propose a very clear and operational objective – stabilising credit cycles. As credit fluctuates more than GDP, macroprudential policy should aim at reducing the fluctuations in credit. In a more general setting, Claessens and co-authors show that the housing and credit cycles coincide and contribute to the building up of financial imbalances, while the equity cycle is less relevant. They recommend countercyclical capital buffers in combination with limits on mortgage lending, such as loan-to-value caps or debt-to-income caps.
Another emerging macroprudential instrument that can limit credit growth is the leverage ratio of the banking system. Gersbach shows that this ratio is sufficiently independent of the short-term interest rate used in monetary policy. This helps to apply the Tinbergen ‘assignment’ rule, namely using different instruments to achieve each of the objectives.
Interestingly, the cross-sectional dimension is moving to centre stage when it comes to macroprudentialism. There are calls, both from politics and academia, for high systemic capital surcharges for the large banks to reduce the ‘too-big-to-fail’ subsidy, as Favara and Ratnovski point out in their chapter. Several countries – such as Switzerland, the US, the UK, Sweden, and the Netherlands – have introduced higher capital charges for their large banks.
Need for European coordination
Special considerations apply to the Eurozone in the presence of the monetary and banking union. Macroprudential policy is even more important in a monetary union. With a ‘one-size-fits-all’ monetary policy, pro-active macroprudential policies are needed to address financial imbalances at the country level.
While there is broad consensus that the financial cycles differ at the country level, there is no consensus on the appropriate level of coordination. Figure 2 depicts the current division of powers. In monetary and supervisory policy, the ECB takes the lead with some contributing role for the national central banks (NCBs) and the national competent authorities (NCAs). In contrast, in macroprudential policy the nation authorities have the first say, with the ECB on the back bumper.
Figure 2. Policy framework for the Eurozone
In this eBook, Sapir, as well as Acharya and Calomiris, argue for a strong role for the ECB. I would like to reinforce this point. If too much is left to the national level, emerging financial imbalances may go unchecked in some countries. Next, there is a risk of inconsistent application of macroprudential tools, while there are strong cross-border stability effects within a monetary and banking union. Moreover, a consistent policy framework for a broader financial union suggests the alignment of policy tools at the same level.
As the macroprudential toolbox is slowly being filled with new instruments, central banks need to learn how to use them. This will not be easy since the exact effect depends on the specifics of a country’s financial system and there may be unintended consequences (see the chapter by Wagner). International experiences are of limited use. Macroprudential policy, just like monetary policy, is more art than science. While central banks tend to be cautious, the high costs of financial crises suggest that it may be better to err on the side of a pro-active macroprudential policy stance, as Gersbach points out in his chapter.
Macroprudential policy requires complete independence from short-term political pressures to deal with the inherent conflict between the short and the long term. This is why independent agencies, such as the central bank or the financial supervisory authority, are made responsible for macroprudential policy. This requires adequate arrangements for democratic accountability, as macroprudential decisions, such as lowering the loan-to-value ratio, can have a major impact on citizens.
Schoenmaker, D and P Wierts (2011), “Macroprudential Policy: The Need for a Coherent Policy Framework”, Duisenberg School of Finance Policy Paper No.13.
Stein, J (2013), “Overheating in Credit Markets: origins, measurement, and policy responses”, remarks at a Research Symposium sponsored by the Federal Reserve Bank of St. Louis, 7 February.