Central banks have been entrusted with the task of developing and implementing measures for limiting systemic risk. They should cope with this task but if they don’t succeed, central banks are risking their credibility.
Among economic policymakers there is a belief that the central banks’ experience in the pursuit of monetary policy and their credibility obtained due to activities aimed at combating inflation will be a model for macroprudential policy. When the central banks extend their mandate to pursuing macroprudential policy, they also risk losing their hard-earned credibility resulting from the efficiently conducted monetary policy.
The term “macroprudential” was used for the first time in 1970s by the Cooke Committee (the precursor of the Basel Committee on Banking Supervision). It became a serious topic among policymakers and economic researchers after the financial crisis of the late 2000s and was promoted as a regulatory approach to manage the systemic risk of the financial sector.
The objective of macroprudential measures is to counteract the build-up of imbalances in the financial system that may lead to significant negative economic consequences. For this reason, macroprudential policy is currently enjoying political support ‒ especially since the memories of the financial crisis are still vivid. In the future, macroprudential policy will be used more frequently. However, by then the memory of the last financial crisis will fade, market participants will reap short-term benefits of the bubbles emerging on the markets, and the political support could be much lower.
In the case of monetary policy, central banks have one main instrument ‒ interest rates, and one measurable objective ‒ inflation. Unfortunately, in the case of macroprudential policy the situation is more complicated, because there is a wide range of instruments and measures available, which are supposed to reflect systemic risk and financial instability. What’s more, at present we cannot expect that in a few years the level of macroprudential policy knowledge will be the same as the one in monetary policy. An additional problem is the appropriate calibration (benchmarking) of macroprudential instruments, especially in the case of countries which have not used them before and must rely to a greater extent on international experience.
The use of macroprudential policy means the co-operation of many institutions, including the fiscal authorities. This could lead the macroprudential decision-making process to become both more politicized and more complicated due to the various points of view. The involvement of an institution responsible for fiscal policy in the conduct of macroprudential policy could result in a potential conflict between fiscal policy and macroprudential policy, as the former is influenced by the political cycle.
This is possible in the short term – for example, strong credit growth during a boom supports economic growth at the expense of weakening it in the longer term. Therefore, in such a case, fiscal institutions may not be inclined to intervene, because there would be pressure against the tightening of the measures (e.g. by changing the level of the counter-cyclical buffer). The necessity of using instruments limiting economic growth in a short period of time, in order to avoid a recession which seems unlikely at a given moment, is often difficult to accept politically. This is the problem of pro-cyclicality known in the sphere of financial regulation, i.e. the activities of market participants and the authorities may increase the adverse volatility of the financial system.
Therefore, the more possibilities and different interests that influence the macroprudential authorities, the bigger the chance of a decision-making paralysis. For this reason, the institutions responsible for macroprudential supervision – just like monetary policy institutions – should be independent from the current political cycle.
On the other hand, institutions responsible for the regulation of the financial system may be prone to premature intervention, especially in the post-crisis period. That is because they are afraid of possible criticism if they fail to detect rising systemic risk, for example, in the form of a price bubble in the assets market. The desire to prevent future crises at all costs may significantly and adversely affect the level of investment and the possibilities of future economic growth.
From a practical point of view, problems with the implementation of macroprudential policy are bound to emerge. Uncertainty regarding the calibration and effectiveness of macroprudential instruments and the institutional structure in many countries mean that there may be significant political opposition to the activities of macroprudential authorities.
For these reasons, entrusting central banks ‒ as institutions with an established independence ‒ with the conduct of macroprudential policy seems to be a good idea. However, the success of macroprudential policy depends on the ability to reach a consensus and access to an appropriate set of instruments.
Central banks have managed to achieve good results in socioeconomic communication, the aim of which is to control inflation expectations. The present challenge is for the central banks to effectively lead communication concerning macroprudential policy. The goal is to successfully counteract or reduce risk in the financial system. If they don’t succeed in this task, it could mean that the efforts to create mechanisms of protection against systemic risk which have been made thus far may not be sufficient. This could result in financial and price instability and the undermining of the credibility of the central banks.
The author is a doctor of economic sciences and works at the NBP (the Polish central bank) Financial Stability Department. The article presents her private views, and is not an expression of the official position of NBP.