Implementing Macroprudential Regulation and Monetary Policies: The Case for Two Committees
This paper represents the author's own views and not necessarily those of the Bank of England or his colleagues on the Financial Policy Committee.
October 2015 | by David Delaney
Policy makers around the world have learned a number of lessons from the global financial crisis (GFC) about requirements for a policy tool kit that will prevent the next financial crisis –or at a minimum considerably lessen the pain of financial cycles for the real economy. We have learned that medium-term price and economic stability is not enough to guarantee financial stability and that the absence of financial stability can cause substantial and prolonged deviations from inflation targets and full employment.
Moreover, monetary policy has not been powerful enough to restore price and economic stability quickly once they have been disturbed by a major financial crisis. Clearly more is needed to prevent such crises from occurring in the first place. Improvements in institution-by-institution risk management and capital and liquidity buffers would help, but viewing each institution separately is not sufficient to preserve financial stability. Externalities to the behavior of individual institutions means that the authorities need to look at the whole system, devising and administering regulations to take account of the interactions and spillovers and to damp the procyclicality that seems naturally to be built into financial markets and their feedback on the economy.
Macroprudential policy—the extra regulatory perspective that does take account of systemic effects—had been a feature of policy in the US and many other industrial economies in the 1950s, 60s, and 70s, and it has remained a key aspect of the regulatory approaches in many emerging market economies in the 2000s. But it fell out of favor in most economies with open and highly developed financial markets, because markets were perceived as having gotten better at distributing and diversifying risks and because markets were undermining the effectiveness of regulation by providing more avenues for regulatory arbitrage.
Now, in the wake of the GFC, macroprudential regulation has been reborn in advanced economies, mostly as a “macroprudential finish” to standard microprudential tools, like capital and liquidity requirements applied to a wider range of institutions that are judged to be systemically important -–but also with changes in market structures, for example the central clearing of derivatives.
But that gives us two types of financial policies with a macro focus—macroprudential and monetary policies. They share a common ultimate objective: preserving economic stability in the interests of maximizing sustained long-term growth. Moreover these two types of policies interact in a number of important ways. That has raised questions about when and how each set of policy tools should be used, who should have their hands on the macroprudential levers and, if they are a different set of hands, how the two authorities should interact. What each set of tools concentrates on is important to my conclusion about governance, so I’ll touch on that, but I will concentrate on the structure of governance, with particular reference to the US and to the Federal Reserve. Should the FOMC or the Board of Governors have authority over macroprudential policy? I will draw some lessons about how policymaking might be structured from the UK, where I am an external member of the macroprudential authority—the Financial Policy Committee. And I’ll point to deficiencies I see in the structure for macroprudential policy in the US beyond the Federal Reserve.