Calibrating Macroprudential Policies in Europe Amid Rising Housing Market Vulnerability

IMF Working Papers, March 24, 2023

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Housing market developments in Europe show "over-stretched valuations amid tightening financial conditions and a cost-of-living crisis," increasing risks of a sustained downturn and exposing trade-offs for macroprudential policy between ensuring financial system resilience and smoothing the macro-financial cycle.
The paper provides detailed considerations on how to (re)set macroprudential policy tools in response to housing-related systemic risk in Europe, including:
- design solutions to avoid unintended consequences during a tightening phase;
- guidance on navigating trade-offs between managing the build-up of vulnerabilities and the macro-financial cycle in a downturn.
The paper proposes a novel framework to measure the effectiveness of tools and avoid overlaps by quantifying the risks addressed by different macroprudential instruments.
The paper introduces a taxonomy to assess a country’s macroprudential stance and whether adjustments to current policy settings are warranted, including the possibility of the relaxation of capital-based tools and possibly some borrower-based measures "in the event of a more severe downturn."

Novel framework: quantifies the risks addressed by different macroprudential instruments to measure tool effectiveness and avoid policy overlaps.
Taxonomy: enables assessment of a country’s macroprudential stance and informs whether policy adjustments (e.g., relaxation of capital-based tools and possibly some borrower-based measures) are warranted under more severe downturn scenarios.

Re-set macroprudential policy tools in response to housing-related systemic risk with attention to:
- avoiding unintended consequences during tightening phases;
- balancing financial stability objectives and smoothing the macro-financial cycle during downturns.
Consider calibrated relaxation of capital-based tools, and potentially some borrower-based measures, if a downturn becomes more severe.

IMF Working Paper — Calibrating Macroprudential Policies in Europe Amid Rising Housing Market Vulnerability