Let’s be modest about what Macroprudential policy can achieve..

An important speech by Klaas Knot of Central Bank of Netherlands. He says we should be weary of what macroprudential policy can achieve. This is contrary to what most other central banker/regulators say which is that macropru policy will bail-us out on the next crisis.

Knot points to three risks facing financial system: Credit growth / leverage, Public and Private indebtedness and real estate. He then looks at available macropru tools tackling these risks and finds that in most risks we do not have any macropru tools.

So what do we conclude from this overview? Allow me to make three observations.

First, the macroprudential framework does not provide a fully-covered system. Contrary to monetary policy that ‘gets into all the cracks’, macroprudential policies are limited to specific parts of the financial system. Available measures are also almost exclusively targeted towards banks, which implies
a potential for risk-shifting beyond the banking sector.

Second, macroprudential measures are mostly targeted at strengthening resilience, but not at addressing the build-up of underlying vulnerabilities. Current available instruments create buffers to better absorb losses when they occur, but they neither improve the functioning of the real economy, nor do they stem the origination of losses. For example, an important systemic risk like corporate indebtedness cannot be directly addressed by macroprudential authorities.

Thirdly, potentially very effective measures often do not fall within the remit of macroprudential authorities. Such measures are often considered too important from an electoral perspective to delegate their activation to independent authorities. These include sovereign risk weights, borrower based limits and preferential tax incentives. They are often part of broader economic trade-offs, thereby however creating a reality that macroprudential authorities cannot employ full ammunition to address systemic risks.

So my main message today is that of macroprudential modesty. Although important frameworks have been developed in the aftermath of the global financial crisis, we cannot regard them to be at par with monetary or fiscal policies. The impact of macroprudential measures are unlikely to be as forceful as
monetary policy, as they at their very best slow down the build-up of stability risks within the financial system.

Hmm…That is an important reality check!

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