Remarks by José Viñals
Brookings Event
September 16, 2013
As prepared for delivery
I. Introduction
Good morning. Let me thank the Brookings Institution for hosting us today and Doug Elliott for his insightful opening remarks.
I would like to focus on one of the key challenges facing today’s generation of policymakers—how to make macroprudential policy work. The global efforts to meet this challenge are essential because these policies can make the financial system more resilient to a range of shocks. This could help prevent future financial crises.
Significant progress has been made, largely through experimentation in several countries, but also through research and policy development by leading academics, practitioners, and international organizations such as the IMF. This morning, the Fund published a paper on the key aspects of macroprudential policy, which represents the culmination of a multi-year policy development effort.
Indeed, we have all come a long way since the beginning of the global financial crisis, when policymakers were shocked to discover a glaring gap in their policy toolkit. At the time, they did not have the means to detect and mitigate risks to the financial system as a whole. These risks had been allowed to grow unchecked in the run-up to the crisis.
Policymakers learned the hard way that systemic risks could not be addressed through the traditional mix of macroeconomic policies and microprudential measures aimed at individual financial institutions. A new approach was needed to fill the policy gap and ensure financial stability in both advanced economies and emerging markets.
Today, macroprudential policy is highly relevant for policymakers in both advanced and emerging economies who are seeking to cope with the side-effects of exceptionally accommodative monetary policies in the countries first hit by the crisis.
In my remarks today, I would like to address the following key issues:
- What are the proper objectives of macroprudential policy?
- Where are the potential synergies and conflicts between macroprudential policy and other policies?
- Which tools are needed, and how should they be used?
- Who should run macroprudential policy?
- What are the main limitations and challenges that have yet to be addressed?
- What is the role of the IMF?
II. What are the proper objectives of macroprudential policy?
Macroprudential policy aims to address systemic vulnerabilities. It can help policymakers deal with two, interrelated drivers of systemic risk:
- One is the risk of shocks to the financial system through swings in credit and liquidity cycles, driven by leverage and herding behavior, the so-called excess procyclicality. By encouraging the buildup of buffers, macroprudential policy can increase the financial system’s ability to absorb shocks and help maintain the provision of credit to the economy.
- Another driver of systemic risk is the buildup of vulnerabilities in certain financial institutions and markets that are highly interconnected within, and across, national borders, creating institutions that are too big to fail.
But there are things macroprudential policy cannot do and should not do. They include controlling asset prices or exchange rate movements, and managing aggregate demand or external imbalances.
While macroprudential policy may have some effects, other policies are more potent in addressing economy-wide imbalances and asset prices. Governments may sometimes be tempted to use macroprudential policy as a substitute for other necessary policies, in order to escape difficult political decisions. They should refrain from doing so. Macroprudential policy is not a panacea.
III. Where are the potential synergies and conflicts between macroprudential policy and other policies?
To achieve its goal, macroprudential policy needs to be complemented by appropriate macroeconomic policies as well as other financial sector measures. The new IMF paper includes a detailed analysis of the interactions between macroprudential policy and a whole range of other measures.
Figure 1. Relationship between Macroprudential and Other Policies
Source: IMF (2013).
Let me focus on the relationship between macroprudential policy and its main “frenemies”—monetary and microprudential policies.1
Monetary and macroprudential policies
In a first-best world, monetary policy can take care of price (and output) stability, while macroprudential policy achieves financial stability. In the pursuit of price stability, monetary policy may nevertheless have undesirable side-effects on financial stability. For example:
- Accommodative monetary conditions in a context of low inflation, may contribute to excessive credit growth, asset bubbles and other financial excesses which may end up compromising future financial stability.
- In small open economies, interest rate increases may be necessary in the face of inflationary pressures, but can draw in capital flows that may contribute to excessive financial risks.
So, what can macroprudential policy do for monetary policy? More effective macroprudential policy can help a lot. In particular, if it has an appropriate range of tools, macroprudential policy will be better able to address the undesired side-effects of monetary policy on financial stability. It thus allows for greater room for maneuver for the monetary authority to pursue price stability.
Also, to the extent that macroprudential policy reduces systemic risks and creates buffers, this helps monetary policy in the face of adverse financial shocks. It can reduce the risk that monetary policy runs into constraints such as the zero lower bound—recently hit by many advanced economies.
Where macroprudential policy is missing or is insufficiently effective—for political economy reasons or because the available tools are imperfectly targeted—monetary policy, while continuing to aim at price stability, needs to take financial stability more into account by leaning against the build-up of financial imbalances.
Particular challenges arise where monetary policy is constrained—such as under fixed exchange rates or in a currency union such as the Euro Area. The monetary policy stance adopted for the area as a whole may then contribute to credit booms and asset bubbles in some countries of the union (as in Ireland or Spain ahead of the crisis). This, in turn, creates a greater need for macroprudential policy. It is important that macroprudential policy levers are available to counter these imbalances at the national level.
In short, strong complementarities and interactions between monetary and macroprudential policies reinforce the need for a strong macroprudential framework. These interactions also call for adequate collaboration between monetary and macroprudential policies.
Macroprudential and microprudential policy
In principle, microprudential supervision should work “hand-in-glove” with macroprudential policy. Revisions made in the wake of the crisis to the Basel Core Principles now place a much stronger emphasis on the need for a macroprudential perspective in supervision.
Will this lead to a happy marriage between the two policies?
Shared information, joint analysis of risks, and strong dialog can reinforce the complementarities between microprudential supervision and macroprudential policy.
Indeed, strong microprudential supervision is essential both to ensure that macroprudential policymakers can draw on supervisory information in risk assessment and to ensure that the macroprudential policy stance is effectively enforced across institutions.
However, tensions may arise between microprudential and macroprudential perspectives, because both policies rely on similar transmission mechanisms.
In “good times,” the microprudential supervisor may often agree that it would be prudent for banks to build up buffers, even though there may be little sense of urgency amid ample profits and limited non-performing loans.
In “bad times”, however, tensions can arise. For example:
- The macroprudential perspective may call for a relaxation of regulatory requirements that impede the provision of credit to the economy, while the microprudential perspective may seek to retain these requirements to protect the health of individual banks.
- Or, as we have seen recently in Europe, microprudential authorities may call for increasing bank capital ratios in bad times, while macroprudential authorities will be concerned that this leads to excessive deleveraging with adverse effects on the economy.
One way of addressing conflicts in “bad times” is to establish sufficient prudential buffers in “good times”. The macroprudential authority may then be in a position to reduce buffers in “bad times” in a manner that respects microprudential objectives.
Where initial buffers prove to be inadequate, conflicts can often still be resolved through well-designed prudential action. For example, encouraging increases in capital ratios in banks to be met by increases in capital levels (the numerator) avoids deleveraging and can align microprudential and macroprudential objectives.
Either way, it is important to establish ex ante institutional mechanisms that allow for both perspectives to be brought to bear in designing policies through the cycle.
IV. Which tools are needed, and how should they be used?
The implementation of macroprudential policy tools remains a work in progress in many countries.
Figure 2. The Macroprudential Policy Wheel
Source: IMF (forthcoming).
The Fund recommends that countries:
- develop the capacity to monitor and analyze systemic risk,
- select and assemble a set of macroprudential instruments,
- calibrate the selected tools,
- monitor regulatory gaps and take timely action to close them; and
- fill data gaps that impede the analysis of risks and create uncertainty about the need to take action.
Let me highlight two issues:
1) Selecting and assembling macroprudential tools
Macroprudential policy cannot rely on a single tool. We recommend that three sets of tools be considered: (i) countercyclical capital buffers and provisions; (ii) sectoral tools, such as limits on loan to value and debt-to income ratios; and (iii) liquidity tools, to contain funding risks from rapid increases in credit.
These sets of tools can reinforce and complement each other in addressing the build-up of risks over time. Interlocking use of these tools can help overcome the shortcomings of any one single tool and enable the policymaker to adjust the overall policy response to a range of risk profiles.
For instance, the introduction of liquidity tools—such as the macroprudential levy in South Korea, or the core funding ratio in New Zealand—may help not just to contain liquidity risks, but also to rein in credit growth.
2) Calibrating macroprudential tools – rules versus discretion
The use of macroprudential tools requires an analysis of the changes in the sources and level of systemic risk; an understanding of the transmission mechanism of the available tools; and an assessment of the costs of policy action.
A key advantage of a rules-based framework is the reduced need to overcome political opposition to the variation of macroprudential tools. However, it is difficult to devise rules that are fully state-contingent, as the financial system evolves and the sources of risks shift over time.
One way of balancing these considerations is to complement tools that work as automatic stabilizers (such as dynamic provisions) with a range of other, more flexible tools that can be targeted and adjusted to evolving risks. Another is to introduce “guided discretion”, based on key indicators but complemented by judgment that takes account of all available information—as envisaged in Switzerland and the United Kingdom.
V. Who should run macroprudential policy?
Institutional arrangements for macroprudential policy will vary across countries, reflecting traditions and political economy considerations. Nonetheless, there are certain principles to ensure the arrangements are effective.
First, it is important that someone is in charge of turning the policy wheel.
Second, the authority charged with conducting macroprudential policy can be (i) the central bank, as in many countries, in particular in emerging Asia, (ii) a dedicated committee within the central bank structure, as in the new arrangements in the United Kingdom, (iii) or a council outside of the central bank structure, but comprising the central bank, as in the United States.
The central bank should play an important role regardless of the precise arrangements, since it combines the necessary expertise to analyze macro-financial risks with an incentive to ensure that macroprudential policy does its job. Moreover, in many countries the central bank is unique in being insulated from lobbying and political pressures, which is important to make macroprudential policy work.
Third, whoever is given the mandate to turn the policy wheel needs to be given adequate powers. Powers are needed to wield tools, but also to gain access to information needed to assess systemic risk, and to initiate an expansion in the range of available tools and their scope of application.
VI. What are the main limitations and challenges that have yet to be addressed?
Despite recent progress, much remains to be done. I see the following limitations and challenges:
1. Where are the systemic risks? Detecting and assessing systemic risk is difficult, not least because of the limited availability of good data. This is particularly relevant in the shadow banking sector. Regulatory arbitrage could further complicate the task as some financial activities migrate from banks to shadows banking.
2. What will be the impact of macroprudential policy tools? There is considerable uncertainty over the transmission mechanism of macroprudential policy. While we have made progress in mapping transmission channels conceptually, the strength of these effects is often still uncertain. We are at the beginning of a long learning process that requires more data and analysis.
3. How to communicate? Communication will be challenging because macroprudential policy is not easily understood. It relies on a range of instruments that may appear technical and yet are often politically controversial. There is much to be learned from the evolving nature of communication by leading central banks, which have expanded their range of policy levers.
4. How to make sure that timely action is taken? Macroprudential policy is subject to a strong bias in favor of inaction. While the benefits of macroprudential action are not visible as they only accrue in the future, the costs are typically felt immediately—by potential borrowers as well as the financial industry. Lobbying pressures and political interference further increase the inaction bias. Will the macroprudential authority be able to take the punch bowl away at the right time, despite the inherent inertia? Strong and explicit governance and institutional arrangements will be essential, but their implementation may have to overcome significant political hurdles.
VII. What is the Role of the IMF?
The IMF can play the role of a global macroprudential facilitator. This involves continued and increasing efforts in a number of areas.
In collaboration with the Financial Stability Board, standard setters and country authorities, we consider it our mandate to help ensure the effective use of macroprudential policy. The Fund will continue to act as a global risk advisor through its multilateral surveillance. It will also step up its macroprudential dialog with its member countries through its bilateral surveillance, financial sector assessment programs, and technical assistance.
Because of the limited empirical data on the use and effectiveness of macroprudential policy, implementation at the national and global levels will rely on a process of trial and error for some time. The Fund will provide platforms for its members to facilitate the exchange of experiences and best practices—which will naturally feed back into the Fund’s own research and policy development. Indeed, this is what we have done on the papers published today.
By facilitating a global dialog, the Fund can promote a better understanding of the spillovers and cross-border stability implications of macroprudential policies. After all, in an interconnected world, even if macroprudential policies are set right at the national level, this does not guarantee that the resulting global mix is conducive to global financial stability.
VIII. Conclusions
Let me conclude by emphasizing the following three key recommendations.
Figure 3. Key Messages
Source: IMF staff.
- Be hopeful. Use macroprudential policy to fill the gap in the policy toolkit.
- Be humble in the face of the numerous challenges facing macroprudential policymakers.
- And finally, don’t abuse a new policy that is meant to complement—not substitute for—other policies.
Ensuring financial stability at the national and global levels is a shared responsibility. Let’s make it happen!
1 Key Aspects of Macroprudential Policy
Figure 1. Relationship between Macroprudential and Other Policies
Source: IMF (2013).
Let me focus on the relationship between macroprudential policy and its main “frenemies”—monetary and microprudential policies.1
Monetary and macroprudential policies
In a first-best world, monetary policy can take care of price (and output) stability, while macroprudential policy achieves financial stability. In the pursuit of price stability, monetary policy may nevertheless have undesirable side-effects on financial stability. For example:
- Accommodative monetary conditions in a context of low inflation, may contribute to excessive credit growth, asset bubbles and other financial excesses which may end up compromising future financial stability.
- In small open economies, interest rate increases may be necessary in the face of inflationary pressures, but can draw in capital flows that may contribute to excessive financial risks.
So, what can macroprudential policy do for monetary policy? More effective macroprudential policy can help a lot. In particular, if it has an appropriate range of tools, macroprudential policy will be better able to address the undesired side-effects of monetary policy on financial stability. It thus allows for greater room for maneuver for the monetary authority to pursue price stability.
Also, to the extent that macroprudential policy reduces systemic risks and creates buffers, this helps monetary policy in the face of adverse financial shocks. It can reduce the risk that monetary policy runs into constraints such as the zero lower bound—recently hit by many advanced economies.
Where macroprudential policy is missing or is insufficiently effective—for political economy reasons or because the available tools are imperfectly targeted—monetary policy, while continuing to aim at price stability, needs to take financial stability more into account by leaning against the build-up of financial imbalances.
Particular challenges arise where monetary policy is constrained—such as under fixed exchange rates or in a currency union such as the Euro Area. The monetary policy stance adopted for the area as a whole may then contribute to credit booms and asset bubbles in some countries of the union (as in Ireland or Spain ahead of the crisis). This, in turn, creates a greater need for macroprudential policy. It is important that macroprudential policy levers are available to counter these imbalances at the national level.
In short, strong complementarities and interactions between monetary and macroprudential policies reinforce the need for a strong macroprudential framework. These interactions also call for adequate collaboration between monetary and macroprudential policies.
Macroprudential and microprudential policy
In principle, microprudential supervision should work “hand-in-glove” with macroprudential policy. Revisions made in the wake of the crisis to the Basel Core Principles now place a much stronger emphasis on the need for a macroprudential perspective in supervision.
Will this lead to a happy marriage between the two policies?
Shared information, joint analysis of risks, and strong dialog can reinforce the complementarities between microprudential supervision and macroprudential policy.
Indeed, strong microprudential supervision is essential both to ensure that macroprudential policymakers can draw on supervisory information in risk assessment and to ensure that the macroprudential policy stance is effectively enforced across institutions.
However, tensions may arise between microprudential and macroprudential perspectives, because both policies rely on similar transmission mechanisms.
In “good times,” the microprudential supervisor may often agree that it would be prudent for banks to build up buffers, even though there may be little sense of urgency amid ample profits and limited non-performing loans.
In “bad times”, however, tensions can arise. For example:
- The macroprudential perspective may call for a relaxation of regulatory requirements that impede the provision of credit to the economy, while the microprudential perspective may seek to retain these requirements to protect the health of individual banks.
- Or, as we have seen recently in Europe, microprudential authorities may call for increasing bank capital ratios in bad times, while macroprudential authorities will be concerned that this leads to excessive deleveraging with adverse effects on the economy.
One way of addressing conflicts in “bad times” is to establish sufficient prudential buffers in “good times”. The macroprudential authority may then be in a position to reduce buffers in “bad times” in a manner that respects microprudential objectives.
Where initial buffers prove to be inadequate, conflicts can often still be resolved through well-designed prudential action. For example, encouraging increases in capital ratios in banks to be met by increases in capital levels (the numerator) avoids deleveraging and can align microprudential and macroprudential objectives.
Either way, it is important to establish ex ante institutional mechanisms that allow for both perspectives to be brought to bear in designing policies through the cycle.
IV. Which tools are needed, and how should they be used?
The implementation of macroprudential policy tools remains a work in progress in many countries.
Figure 2. The Macroprudential Policy Wheel
Source: IMF (forthcoming).
The Fund recommends that countries:
- develop the capacity to monitor and analyze systemic risk,
- select and assemble a set of macroprudential instruments,
- calibrate the selected tools,
- monitor regulatory gaps and take timely action to close them; and
- fill data gaps that impede the analysis of risks and create uncertainty about the need to take action.
Let me highlight two issues:
1) Selecting and assembling macroprudential tools
Macroprudential policy cannot rely on a single tool. We recommend that three sets of tools be considered: (i) countercyclical capital buffers and provisions; (ii) sectoral tools, such as limits on loan to value and debt-to income ratios; and (iii) liquidity tools, to contain funding risks from rapid increases in credit.
These sets of tools can reinforce and complement each other in addressing the build-up of risks over time. Interlocking use of these tools can help overcome the shortcomings of any one single tool and enable the policymaker to adjust the overall policy response to a range of risk profiles.
For instance, the introduction of liquidity tools—such as the macroprudential levy in South Korea, or the core funding ratio in New Zealand—may help not just to contain liquidity risks, but also to rein in credit growth.
2) Calibrating macroprudential tools – rules versus discretion
The use of macroprudential tools requires an analysis of the changes in the sources and level of systemic risk; an understanding of the transmission mechanism of the available tools; and an assessment of the costs of policy action.
A key advantage of a rules-based framework is the reduced need to overcome political opposition to the variation of macroprudential tools. However, it is difficult to devise rules that are fully state-contingent, as the financial system evolves and the sources of risks shift over time.
One way of balancing these considerations is to complement tools that work as automatic stabilizers (such as dynamic provisions) with a range of other, more flexible tools that can be targeted and adjusted to evolving risks. Another is to introduce “guided discretion”, based on key indicators but complemented by judgment that takes account of all available information—as envisaged in Switzerland and the United Kingdom.
V. Who should run macroprudential policy?
Institutional arrangements for macroprudential policy will vary across countries, reflecting traditions and political economy considerations. Nonetheless, there are certain principles to ensure the arrangements are effective.
First, it is important that someone is in charge of turning the policy wheel.
Second, the authority charged with conducting macroprudential policy can be (i) the central bank, as in many countries, in particular in emerging Asia, (ii) a dedicated committee within the central bank structure, as in the new arrangements in the United Kingdom, (iii) or a council outside of the central bank structure, but comprising the central bank, as in the United States.
The central bank should play an important role regardless of the precise arrangements, since it combines the necessary expertise to analyze macro-financial risks with an incentive to ensure that macroprudential policy does its job. Moreover, in many countries the central bank is unique in being insulated from lobbying and political pressures, which is important to make macroprudential policy work.
Third, whoever is given the mandate to turn the policy wheel needs to be given adequate powers. Powers are needed to wield tools, but also to gain access to information needed to assess systemic risk, and to initiate an expansion in the range of available tools and their scope of application.
VI. What are the main limitations and challenges that have yet to be addressed?
Despite recent progress, much remains to be done. I see the following limitations and challenges:
1. Where are the systemic risks? Detecting and assessing systemic risk is difficult, not least because of the limited availability of good data. This is particularly relevant in the shadow banking sector. Regulatory arbitrage could further complicate the task as some financial activities migrate from banks to shadows banking.
2. What will be the impact of macroprudential policy tools? There is considerable uncertainty over the transmission mechanism of macroprudential policy. While we have made progress in mapping transmission channels conceptually, the strength of these effects is often still uncertain. We are at the beginning of a long learning process that requires more data and analysis.
3. How to communicate? Communication will be challenging because macroprudential policy is not easily understood. It relies on a range of instruments that may appear technical and yet are often politically controversial. There is much to be learned from the evolving nature of communication by leading central banks, which have expanded their range of policy levers.
4. How to make sure that timely action is taken? Macroprudential policy is subject to a strong bias in favor of inaction. While the benefits of macroprudential action are not visible as they only accrue in the future, the costs are typically felt immediately—by potential borrowers as well as the financial industry. Lobbying pressures and political interference further increase the inaction bias. Will the macroprudential authority be able to take the punch bowl away at the right time, despite the inherent inertia? Strong and explicit governance and institutional arrangements will be essential, but their implementation may have to overcome significant political hurdles.
VII. What is the Role of the IMF?
The IMF can play the role of a global macroprudential facilitator. This involves continued and increasing efforts in a number of areas.
In collaboration with the Financial Stability Board, standard setters and country authorities, we consider it our mandate to help ensure the effective use of macroprudential policy. The Fund will continue to act as a global risk advisor through its multilateral surveillance. It will also step up its macroprudential dialog with its member countries through its bilateral surveillance, financial sector assessment programs, and technical assistance.
Because of the limited empirical data on the use and effectiveness of macroprudential policy, implementation at the national and global levels will rely on a process of trial and error for some time. The Fund will provide platforms for its members to facilitate the exchange of experiences and best practices—which will naturally feed back into the Fund’s own research and policy development. Indeed, this is what we have done on the papers published today.
By facilitating a global dialog, the Fund can promote a better understanding of the spillovers and cross-border stability implications of macroprudential policies. After all, in an interconnected world, even if macroprudential policies are set right at the national level, this does not guarantee that the resulting global mix is conducive to global financial stability.
VIII. Conclusions
Let me conclude by emphasizing the following three key recommendations.
Figure 3. Key Messages
Source: IMF staff.
- Be hopeful. Use macroprudential policy to fill the gap in the policy toolkit.
- Be humble in the face of the numerous challenges facing macroprudential policymakers.
- And finally, don’t abuse a new policy that is meant to complement—not substitute for—other policies.
Ensuring financial stability at the national and global levels is a shared responsibility. Let’s make it happen!
1 Key Aspects of Macroprudential Policy
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