Finance authorities and economists have embraced macroprudential policy with startling speed. An obscure concept only a few years ago, people like me now drop “macropru” in a tweet with complete certainty that everyone will know what we are talking about. Yet, there’s an open secret about macropru: no one knows for certain that it works.
The experts are working on it. Months back, some officials at the Bank of Canada and the International Monetary Fund got the idea of hosting a workshop on macroprudential policy — the use of targeted policies such as minimum loan-to-income ratios to receive credit to curb the risk of financial crises — and the role of central banks in financial stability. Separately, the Centre for International Governance Innovation (CIGI) and the Peterson Institute for International Economics were thinking about doing something similar. The two institutions and the two think tanks eventually joined forces to host a mostly private event in Ottawa during the first week of May.
Chatham House rules prevent me from naming the participants, but trust me when I say there were a lot of smart people hanging around the Westin Hotel last week. The gathering ended without definitive answers, but I may have observed the beginning of a consensus on the proper role of central banks in achieving financial stability. Few, if any, of the participants thought asset-prices bubbles should be deflated with monetary policy. Sweden’s misadventure in using the policy rate to cool housing prices has emerged as a cautionary tale. The Riksbank increased the repo rate to 2 percent in 2011 from almost zero in the aftermath of the financial crisis before the broader economy was ready for it. The repo rate now is one of the lowest official rates in the world at -0.5 percent as the central bank struggles to meet its inflation target.
“Monetary policy is too blunt an instrument to be used to mitigate financial vulnerabilities,” Lawrence Schembri, a deputy governor at the Bank of Canada, said at the workshop’s closing panel, which was open to the press.
There was less certainty about who ultimately is responsible for macroprudential policy. Most of the public likely assumes that it is the central bank. But aside from a few exceptions, such as the Bank of England, that tends not to be the case. Not that central bankers appear to want the responsibility.
“The public often sees central banks as responsible for financial stability, but, in practice, this is a mandate the banks rightly share with the government and other financial regulators and supervisors,” Schembri said.
If not the central banks, then who? A committee of regulators is a popular model, but perhaps not the US’s Financial Stability Oversight Council (FSOC), which has 10 voting members and 5 non-voting members. The body is too big to be effective, and the even number of votes raises questions about what the group would do in the face of a particularly difficult decision. The FSOC also lacks independence because the treasury secretary chairs the committee.
But at least Americans know who is in charge of macropru. Countries such as Australia and Canada operate without such clarity. In Australia, the bank regulator keeps an eye on the overall financial system while ensuring financial institutions are safe from insolvency. The leaders of Canada’s main financial regulators meet informally and never report to the public. Instead, they advise the finance minister through the deputy minister of finance, who is a member of the committee. Schembri defended such informal arrangements.
“The framework’s form matters less than its function,” he said. “The measure of success should be macroprudential outcomes, namely lower systemic risk and fewer instances of severe financial stress.”
Fair point. Australian and Canadian officials have avoided financial calamity while others haven’t. The issue is accountability. In the age of Twitter and blockchain, it is difficult to justify that such an important regulatory function should take place in secrecy.
Malcolm Knight, a distinguished fellow at CIGI and former No. 2 at the Bank of Canada, said an independent entity could publish real-time data that would allow market participants to price emerging threats to the financial system accordingly. Knight also said such a body should have a mandate to act on its own accord, just as a central bank has the freedom to do the needful to meet its inflation target.
“Just think how relevant your fire department would be if all it could do was issue warnings,” Knight said.
In response to a question, Schembri acknowledged there was merit in the arguments for an independent macroprudential regulator. However, he didn’t say whether he agreed; it is a question politicians must answer, he said. No finance or elected officials presented at the workshop. It probably is time to involve them in the debate.