Blog Post

G20 and macroprudential policy

At the upcoming G20 meetings the issue what can be done to avoid a repetition of the current deep financial crisis will again be debated. Much attention and criticism will be directed to central banks. That is unavoidable: central banks must never again permit the development of financial imbalances that are large enough to lead […]

By: Date: April 20, 2010 Topic: Global Economics & Governance

At the upcoming G20 meetings the issue what can be done to avoid a repetition of the current deep financial
crisis will again be debated. Much attention and criticism will be directed to central banks. That is unavoidable: central banks must never again permit the development of financial imbalances that are large enough to lead to the collapse of major parts of the financial system when they unwind. In the future, policy makers must “lean against the wind” and tighten financial conditions if they perceive that imbalances are forming, even if there is little hard data to rely on. And they must be mindful that the costs of acting too late can dwarf those of acting too early.

But monetary policy is not the best tool to use for this purpose. Interest rates have simply too blunt effects to deal with financial imbalances, which are typically localised in particular market segments, institutions or, in
the euro area, countries. To slow down the growth of such imbalances, interest rates would have to be raised by implausibly large amounts which would depress economic activity overall and would hurt other segments
of the economy.

Furthermore, within the euro area it is not desirable to use monetary policy to deal with financial imbalances that only affect some countries. While tighter monetary policy might have been useful to limit housing
bubbles in Spain or Ireland, it would have made for an even weaker housing market in Germany. Of course, this is well-known to policy makers and precisely the reason why so much time and effort is being spent on
developing macroprudential tools – non-interest rate tools – that can be used to constrain financial activity and prevent bubbles from forming. This important process has just started and much work remains to be
done. To give it additional impetus, the G20 must focus squarely on it. What would a new macroprudential regime look like? It will have six important characteristics.

First, the new regime must be international in scope. This is why the G20’s attention is crucial. One common unintended consequence of regulation is that financial activity simply shifts to financial centres with a more
liberal regime, as evidenced most famously by Regulation Q in the US that led to the establishment of the euro dollar market in London in the 1960s. Of course, one could argue that if risky financial activities move abroad,
they are somebody else’s problem. But in the modern day, financial markets are closely integrated across the world and a crisis in one country can spread globally in little time. Thus, regulation must be international. In
turn, this implies that international agreement must be reached and that differences, such as those regarding hedge funds, must be overcome.

Second, it must have a broad coverage and include all institutions that are highly leveraged or engaged in maturity transformation. One important factor that led to the adoption of the low-regulation regime that
created the conditions for the crisis was that during the tightly controlled regime of the 1970s firms avoided regulation by shifting financial activities to the unregulated sector. To prevent this from happening again, the
new regime must not focus solely on deposit-taking institutions but cover as many financial institutions as possible.

Third, macroprudential policy must be transparent and predictable. To limit the procyclicality of the financial system, the macroprudential policy instruments will be varied over time. In financial booms and busts policy
makers will thus rely on those instruments that they feel will most effectively deal with the precise imbalances diagnosed. To avoid that such policy changes trigger unexpected and therefore potentially harmful swings in asset prices, policy must be predictable. That requires transparency about the reasons for policy changes and the authorities’ assessment of financial conditions.

Fourth, there is no single instrument that can be relied upon to ensure financial stability, and the macroprudential regime must make use of a whole range of available tools, even though some have shortcomings. Thus, pro-cyclical capital requirements, leverage ratios, loan-to-value ratios and other tools all have a role to play. A pragmatic approach must be taken.

Fifth, macroprudential policy must be conducted together with monetary policy. While macroprudential policy, in contrast to interest rate policy, can be focussed on the market segment that raises financial stability
concerns, such as real estate lending or lending to hedge funds, both affect the economy in broadly similar ways, and it is therefore important that they are co-ordinated carefully.

Sixth, the task of setting macroprudential policy must be determined jointly by representatives from the central bank and all government agencies with responsibility in this area. International cooperation is also essential and attention from the G20 is therefore desirable. Given the close links between monetary and macroprudential policy and the fact that the crisis has shown that the cooperation between central banks and other authorities responsible for financial stability has not always functioned as well as hoped for, it is crucial that the authority for setting macroprudential policy at the national level is vested in one body.

At the international level, these bodies must maintain close contacts. Constructing a well-functioning macroprudential regime with a global dimension is no small task. The leadership of the G20 is therefore
essential.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic More by this author

Blog Post

Global income inequality is declining – largely thanks to China and India

Income inequality among citizens of 146 continues to fall, though at a somewhat reduced pace, according to the updated Bruegel dataset. Income convergence of China and India accounts for the bulk of the decline in global income inequality from 1988-2015.

By: Zsolt Darvas Topic: Global Economics & Governance Date: April 19, 2018
Read about event More on this topic

Past Event

Past Event

The current state and future of the world trading system

This event will discuss the current state of the multilateral trading system and how it might evolve in the future.

Speakers: Iana Dreyer, Marc Vanheukelen, Everton Vargas, André Sapir and Xia Xiang Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 19, 2018
Read about event More on this topic

Upcoming Event

Apr
25
07:45

What European trade policy in face of an emerging global trade war

On 25 April Bruegel is pleased to host Bernd Lange, Chair of the European Parliament's committee on International Trade.

Speakers: André Sapir, Bernd Lange and Guntram B. Wolff Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Apr
24
12:00

European development policy in a global context

What is the role of Europe in development finance and how effective is the current institutional structure? How can we leverage the private sector to support development objectives?

Speakers: Cecilia Akerman, Sir Suma Chakrabarti, Thierry Déau, Marjeta Jager and Jean Pisani-Ferry Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More by this author

Podcast

Podcast

Director's Cut: EU risks US tariff pain in standing by the WTO

As global trade war continues to unfold, Bruegel director Guntram Wolff is joined for this Director's Cut of 'The Sound of Economics' podcast by Bernd Lange MEP, chair of the Committee on International Trade (INTA), to discuss Europe's options.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: April 18, 2018
Read article More on this topic

Blog Post

Free trade in Africa: An important goal but not easy to achieve

The signing of the African Continental Free Trade Agreement and the Kigali Declaration may signal a new push towards economic integration on the African continent. However, it remains to be seen how many more countries sign up, how successfully 'phase two' is implemented later this year, and whether the agreement can be built upon to more comprehensively promote trade in services and a reduction of non-tariff barriers.

By: Marek Dabrowski and Yana Myachenkova Topic: Global Economics & Governance Date: April 13, 2018
Read article More on this topic More by this author

Opinion

US Tariffs Aim to Contain China’s Technological Rise

While tension increases with each of the imports listed under the new tariffs, it now seems clear that the US are trying to slow down China's technological advances. Though such a protectionist attitude represents an obstacle, China should consider it an opportunity to strengthen relations with its Asian neighbours and the EU.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: April 10, 2018
Read article More on this topic More by this author

Opinion

What Are the Targets in the US–China Trade War?

Following the US announcement of new, high tariffs on imports, China is answering the Trump administration by applying its own series of tariffs. In this article, the author identifies the list of products that each country will be targeting, going beyond purely trade issues as each attempts to weaken the other.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: April 10, 2018
Read about event More on this topic

Upcoming Event

May
25
08:30

Where is China’s financial system heading? Implications for Europe

An event on the Chinese Banking Sector.

Speakers: Alicia García-Herrero and Guntram B. Wolff Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More by this author

Opinion

How Should the EU Position Itself in a Global Trade War?

It is high time for the EU to work on more than just wishful thinking in response to the US challenge to global trade. With the first cracks appearing in the multilateral system, it will be difficult for the EU to maintain a middle course between the US and China.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance, Global Economics & Governance Date: April 5, 2018
Read article More on this topic More by this author

Blog Post

Milton Friedman's " The role of monetary policy" - 50 years later

In March 1968, Milton Friedman’s “The Role of Monetary Policy” - after his famous presidential address to the American Economic Association - was published in the American Economic Review. 50 years later, economists reflect on this famous work.

By: Silvia Merler Topic: Global Economics & Governance Date: April 3, 2018
Read article More on this topic More by this author

Podcast

Podcast

Director’s Cut: A global trade triumvirate?

In this week’s Director’s Cut of ‘The Sound of Economics’ podcast, Bruegel director Guntram Wolff hosts a discussion with Bruegel fellows Alicia García-Herrero and André Sapir on where Europe will position itself between the two major trading powers of China and the United States if relations continue to cool.

By: The Sound of Economics Topic: Global Economics & Governance Date: March 27, 2018
Load more posts