Blog Post

The political economy of macroprudential policy

What’s at stake: the emergence of renewed interest in macroprudential policy has characterised the aftermath of the great recession. There is not yet full agreement on what the tasks of macroprudential policy is or how it should be carried out, but there is a clear understanding that there is an important political economy dimension to it. We review some of the recent contribution on this.

By: Date: December 12, 2016 Topic: European Macroeconomics & Governance

Jon Danielsson and Robert Macrae write on VoxEU that the fatal flaw in macroprudential policy is that it ignores political risk, when political risk may be a major cause of systemic financial risk. Brexit, the rise of populist parties in Europe and the election of Donald Trump as President of the Unidìted States of America are examples of political risks that could potentially have financial stability repercussion. Yet, political risk is largely missing from the macroprudential debate, which makes it institutionally difficult for the financial authorities to publicly anticipate crises that have predominantly political causes, and difficult also to mitigate crises once they happen. If financial regulators take steps to address political risk to achieve macroprudential stability, they put themselves in a dangerous position as being involved in a political debate with macroprudential consequences jeopardises their reputation for impartiality, threatens their independence, and affects their ability to execute both macropru and monetary policies. If the authorities visibly react to political initiatives that affect financial stability, there is a danger this would be interpreted as frustrating or twisting democratic decisions.

The successful implementation of macroprudential policy demands among other things that macroprudential authorities have legitimacy, a reputation for impartiality, and political support. It is often assumed that macropru has the similar legitimacy to monetary policy, but Danielsson and Macrae disagree, arguing that the macropru policymaker is faced with a complex, ill-defined policy domain in which there is not a clear consensus on either the problem or the objective. This makes it harder to mobilise the sort of political support that monetary policy can get and may frustrate the preventive role of macroprudential, condemning it to be solely reactive and thus less effective.

Part of the reasons why the exercise of macroprudential policy is prone to be politically sensitive, is the fact that financial cycles can have an impact on fiscal positions. It follows that fiscal policy may have a role to play in preventive macroprudential policy. Borio, Lombardi and Zampolli argue that this aspect of financial boom and busts has frequently been neglected, and yet the latest financial crisis and history show that financial cycles can wreak havoc with public finances. They argue that this warrants the designing of fiscal policy in a way consistent with this threat, so as not to endanger the sovereign’s creditworthiness and retain valuable fiscal space. In this paper, we have taken a first step in that direction.

The ultimate objective should be to design fiscal policy as part of a broader macro-financial stability framework aimed at taming the financial cycle and ensuring sustainable and balanced growth. Taming the financial cycle is not a task that can be left to macroprudential measures alone, and monetary and fiscal policies have a role to play. For fiscal policy, this is not just a matter of ensuring that it retains fiscal space to address the financial bust without endangering the sovereign’s creditworthiness or having it become a source of macroeconomic instability more generally. Fiscal policy ought to play a more proactive role to restrain financial booms in the first place. This means leaning more deliberately against financial booms, possibly with corresponding targets for deficits and debt, and possibly using the tax code and other fiscal instruments to remove any bias in favour of debt over equity.

Andrew Baker argues the emerging political economy of macroprudential regulation revolves around five paradoxes. The first three of these are paradoxes that characterise the financial system and are identified by the macroprudential perspective: the fallacies of composition; the  procyclical paradox of credit and the paradox of financial instability. In seeking to respond to these paradoxes, macroprudential policy, generates a further two distinctly institutional and political paradoxes: the political paradox of countercyclical policy and technocracy’s depoliticisation and legitimacy paradox. The last of these is a central bankers’ paradox which relates to the source of independent central bank authority and the difficulty of building legitimacy and public support for macroprudential regulation. Baker argues that functioning macroprudential regulation is about executing a technocratic control project that rests on a depoliticisation strategy, that in turn risks politicising central banks, exposing their claims to technical authority to critical scrutiny and potential political backlash. What macroprudential policy regimes require, is a sense of social purpose that is plausible and intuitive to the public at large and therefore politically saleable. The difficult question facing macroprudential regulation is who should articulate and develops this sense of wider social purpose

Lucy Goodhart looks at macro-prudential policy and the new political economy of the Federal Reserve. She argues that Implementing macroprudential policy carries the potential for distributional conflict with the largest financial firms and the politicization of central bank policy. In light of this risk, she analyses the institutional implications of macro-prudential policy for the US Federal Reserve, based on interviews with financial regulators, including Fed staffers and policy makers, and with journalists who report on financial regulation. Based on these sources, she identifies the factors that contributed to Fed autonomy in the conduct of monetary policy during the Volcker Revolution and assess the extent to which those same factors hold for macro-prudential policy.


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.

View comments
Read article More on this topic More by this author

Blog Post

The debate on euro-area reform

A paper jointly written by 14 French and German economists set off a debate about the reform of euro-area macroeconomic governance. We review economists’ opinions about it.

By: Silvia Merler Topic: Finance & Financial Regulation Date: April 16, 2018
Read article More on this topic More by this author

Blog Post

Latvia’s money laundering scandal

Latvia’s third largest bank ABLV sought emergency liquidity from the ECB and eventually voted to start a process of voluntary liquidation, after being accused by US authorities of large-scale money laundering and having failed to produce a survival plan. What does it mean for the ECB?

By: Silvia Merler Topic: Finance & Financial Regulation Date: April 9, 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

Blog Post

The Brexit Transition Deal

Michel Barnier, the European Union’s Brexit negotiator, and David Davis, Britain’s Brexit secretary, announced a transition deal on March 19. We review recently published opinions about the deal and its implications.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: March 26, 2018
Read article More on this topic More by this author

Blog Post

Central banks in the age of populism

Two years of elections have shown that we live in an age of increasing political and economic populism. What are the consequences of that for central banks? We explore opinions about it, from both 2017 and more recently.

By: Silvia Merler Topic: Finance & Financial Regulation Date: March 19, 2018
Read article More on this topic More by this author

Blog Post

Are we steel friends?

The U.S. administration is considering to impose tariffs on steel (25%) and aluminium (10%), based on a national security argument. We review economists’ views about this major shift in U.S.’ trade policy.

By: Silvia Merler Topic: Global Economics & Governance Date: March 12, 2018
Read article More on this topic More by this author

Blog Post

Getting accustomed to Brexit - UK and the customs union scenario

The Labour Party’s support of customs union membership has the potential to change the course of Brexit, with 13 months left to close negotiations. This week we review the commentary around the possibility of a post-Brexit EU-UK Customs Union.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: March 5, 2018
Read article More on this topic More by this author

Blog Post

The Italian elections

Italy goes to the polls on March 4, with a new electoral law that is largely viewed as unable to deliver a stable government. We review recent opinions and expectations,  as well as economists’ assessment of the cost/coverage of parties’ economic promises. 

By: Silvia Merler Topic: European Macroeconomics & Governance Date: February 26, 2018
Read article More by this author

Blog Post

Venezuela’s hyperinflation

The International Monetary Fund forecasts Venezuelan inflation spiralling to 13,000 percent this year. As President Maduro is expected to introduce the “petro” cryptocurrency next week, we review economists’ recent (and less recent) opinions on the current crisis.

By: Silvia Merler Topic: Global Economics & Governance Date: February 19, 2018
Read article More on this topic More by this author

Blog Post

The stock market slide

The stock market dropped last week, leading to questions and debates as to the underlying reasons. We review economists’ views on the issue.

By: Silvia Merler Topic: Finance & Financial Regulation Date: February 12, 2018
Read article More on this topic More by this author

Blog Post

Economies of States, Economies of Cities

Both in Europe and the US, economists are starting to notice how the economies of cities have been sometimes diverging from the economies of states. While some areas thrive, others may be permanently left behind. Maybe it is time to adopt a more clearly sub-national perspective. We review recent contributions on this issue.

By: Silvia Merler Topic: Global Economics & Governance Date: February 5, 2018
Read article More on this topic More by this author

Blog Post

Rebuilding macroeconomics: Initial reflections on a major theory project

The ‘Rebuilding Macroeconomic Theory Project’ came to an end in the most recent volume of the Oxford Review of Economic Policy; how were the various papers’ conclusions received?

By: Konstantinos Efstathiou Topic: Global Economics & Governance Date: January 29, 2018
Load more posts