Transcript financial stability

Macroprudential Policy
(And Its Coordination With Monetary Policy)
In Low Interest Rate Environment
Jan Frait
Executive Director
Financial Stability Department
I.
Motivation for Presentation:
Pre-Crisis Consensus and Post-Crisis Lessons
Pre-crisis consensus – benign neglect
• Monetary policy tools should be deployed to deliver price stability.
• Minimazion of output gap a secondary objective.
• Microprudential regulation and supervision should be used to
achieve financial stability.
• Financial regulation not significant for macroeconomic policy.
• Little focus on systemic risk and potential macroeconomic impact.
• Central bank should respond to financial market and asset market
developments only insofar as they affect inflation.
• Financial sector and financial frictions not employed in
macroeconomic models used by central banks.
• Great Moderation: steady decline in volatility of inflation and
output increased confidence in pre-crisis policy framework.
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Post-crisis lessons
• Price stability alone not enough for maintaining financial stability.
• Financial instability can have negative feedback effects on price
stability and the real economy.
• Ensuring the financial soundness of individual institutions is also
not sufficient for guaranteeing financial stability.
• Macroprudential policy tools to be added to the traditional
approaches of microprudential regulation and supervision.
• Renewed discussion about whether the central bank should take
the risks to financial stability into account when setting its
monetary policy tools (Woodford, 2012; Frait, Komárková and
Komárek, 2011).
• A full consensus on this issue has not been reached so far.
• Central bankers` and Bank for International Settlements (BIS)
views on the issue remain largely different.
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Setting for today's debate
• Central banks` position – two objectives and two policies:
• Accommodative monetary policies with low to negative rates or
QEs needed for maintaining price stability and safeguarding
credibility of price-stability commitment.
• Potential undesirable effects of loose monetary policy on the risks
to financial stability can be largely mitigated by applying suitable
macroprudential tools.
• BIS view – macroprudential policy alone cannot do the job:
• Ultra loose monetary policy stance might affect tightness of
borrowing constraints and probability of default (Goodhart et al.,
2009), risk-taking of financial intermediaries (Borio and Zhu, 2008),
or aggregate financial prices (Bruno and Shin, 2012).
• This presentation looks at interconnected issues:
• Macroprudential policy framework.
• Joint-effects, potential conflicts and coordination of macroprudential
and monetary policies.
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II.
Monetary Policy and Macroprudential Policy:
Rivals or Teammates?
Transmission mechanism (1)
• Monetary authority´s dream:
Monetary Policy
Tools
Macroprudential
Policy Tools
Price Stability
Financial Stability
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Transmission mechanism (2)
• Monetary authority´s dream:
Monetary Policy
Tools
Macroprudential
Policy Tools
Price Stability
Financial Stability
• The reality:
Monetary Policy
Tools
Price Stability
Transmission
Mechanism
Macroprudential
Policy Tools
Financial Stability
• The black box is always complex – various stages and channels.
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Transmission mechanism (3)
• The models central banks currently use for monetary policy
purpose work primarily with the interest rate and exchange rate
channels.
• Changes to monetary policy tools also act via the credit demand
and supply channels, the asset price channel and the risk-taking
channel.
• Bank lending channel (also bank capital and bank regulation
channels):
• acts via the bank credit supply,
• CB affects banks’ access to funding sources and their price; clients‘
debt servicing cost and creditworthiness.
• Balance sheet channel:
• acts via the credit demand,
• affects the ability of households and firms to obtain credit through
changes in collateral valuation.
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Transmission mechanism (4)
• Asset price channel:
• households (the wealth effect):  i   PA   W   C
• corporations (the “Tobin’s q” effect) :  i   PE   Costs   I
• Risk-taking channel:
• low rates (in the long-run)  incentive to expand the balance
sheets of banks and invest in more risky assets (to attain the
original target rates of return (Diamond and Rajan, 2012)),
•  higher lending and softer lending conditions (Borio and Zhu,
2008),
•  higher proportion of market-based funding with compressed risk
premia and the amount of maturity transformation (Adrian and
Liang, 2014).
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Policy coordination
• Macroprudential and monetary policy tools are not independent.
• They affect both credit and monetary conditions via their effect on
lending standards and credit growth.
• Anything that affects the availability and price of credit also affects
credit growth and thus also monetary policy transmission.
• Central banks therefore have to carry out analyses of policies
interactions and strive for their coordination.
• In some situations it may be desirable for them to act in the same
direction.
• In other situations the two can come into conflict because of a need
for them to work in opposite directions.
• The right policy mix depends on the intersection of two different
cycles – the business cycle and the financial cycle.
• Different properties of both cycles makes coordination of both
policies challenging (Frait, Malovaná and Tomšík, 2015).
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Monetary and macroprudential policies interactions
• How might monetary stance affect financial stability?
Source: BoE
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Monetary and macroprudential
policies interactions
• How might macroprudential stance affect monetary stability?
Source: BoE
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Mutual support or conflict?
• In a perfect world, both policies are complementary and mutually
reinforcing, in reality, one policy affects the playing field of the
other and conflicts may arise.
• Working in the same direction (pursuing MP objective supports
MaP goal):
• financial crisis and recession → lower interest rates → support of
credit and demand → debt service stabilization → asset price
stabilization → economy back to normal.
• Opposite direction (pursuing MP objective harms MaP goal):
• inflation below target → low policy interest rates → banks and their
clients view risks as low → easing of lending standards → fast credit
growth → asset price growth → rise in demand for credit to purchase
assets → risk of excess credit and asset price boom.
• elevated inflation pressures → high interest rates → client opt for
„better priced“ loans in foreign currencies → FX currency
appreciation → high debt service of unhedged borrowers → defaults
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and banking sector stress.
Proper mix of policies
• The strength of potential conflict depends on:
• position in the financial and business cycle (Borio, 2014b),
• openness of the economy,
• sort of shocks the economy is currently exposed to.
• Suitable combinations of responses of the two policies below:
• in truly good or bad times the choice is obvious.
• sometimes it can be very hard to decide on the right mix in reality.
Rapid credit
growth and rising
asset prices
Decline in credit
and falling asset
prices
Monetary pol.
Macroprud. pol.
Monetary pol.
Macroprud. pol.
Inflationary pressures Disinflationary pressures
Strong
Weak
Strong
Weak
demand
demand
demand
demand
Tightening >
Tightening Easing < IT
Easing
IT
Tightening
Tightening
Tightening
Tightening
Tightening <
Tightening
Easing
Easing > IT
IT
Easing
Easing
Easing
Easing
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Mix for financially bad times
• Example #1
• During a period of financial bust, a rise of interest rates to respond
to increased inflation pressures would further dampen credit growth
and in turn economic recovery.
• The right response is to partially ease macroprudential policy.
Rapid credit
growth and rising
asset prices
Decline in credit
and falling asset
prices
Monetary pol.
Macroprud. pol.
Monetary pol.
Macroprud. pol.
Inflationary pressures Disinflationary pressures
Strong
Weak
Strong
Weak
demand
demand
demand
demand
Tightening >
Tightening Easing < IT
Easing
IT
Tightening
Tightening
Tightening
Tightening
Tightening <
Tightening
Easing
Easing > IT
IT
Easing
Easing
Easing
Easing
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Potential conflict
• Example #2
• During a period of financial boom, a reduction of interest rates to
combat below-target inflation could further increase credit growth
and demand for risky assets.
• From the conceptual perspective, the right response is to tighten
macroprudential policy
• ..pre-emptively tighten the monetary conditions too?
Rapid credit
growth and rising
asset prices
Decline in credit
and falling asset
prices
Monetary pol.
Macroprud. pol.
Monetary pol.
Macroprud. pol.
Inflationary pressures Disinflationary pressures
Strong
Weak
Strong
Weak
demand
demand
demand
demand
Tightening >
Tightening Easing < IT
Easing
IT
Tightening
Tightening
Tightening
Tightening
Tightening <
Tightening
Easing
Easing > IT
IT
Easing
Easing
Easing
Easing
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Monetary and macroprudential policies interactions
• Proper coordination of the two policies might be very difficult
due to different probabilities of failure to fulfill the two main
objectives:
• risk of not meeting inflation target in the short term implied by the
forecast will be viewed as most likely development,
• materialization of systemic risk that builds up will be seen as
potential in the medium term only.
• Preference is unlikely to be given to the financial stability
objective, as this would require a consensus that the risk of a
future financial crisis has exceeded a critical level.
• Such consensus was reached neither before the recent financial
crisis, nor in economies facing credit/property boom today.
• Macroprudential policies expected to save the day:
• restrain excessive credit growth, contain asset price
accelerations, or at least keep the bank resilient.
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BIS view on limits of macroprudential policy (Borio, 2014c)
• Effectiveness of macroprudential measures in constraining
financial booms is limited:
• few well targeted tools may be superior to a vast array,
• rule-based arrangements limit the need for discretionary action,
they can limit the risk of regulatory drift,
• conservative DTI ratios and, to a lesser extent perhaps, LTV
ratios, calibrated with economic conditions, are comparatively
more effective than increases in loan provisions or capital
requirements.
• Macroprudential policy cannot bear the whole burden:
• macroprudential policy must be part of the answer but it cannot
be the whole answer,
• other policies also need to play their part, not least monetary and
fiscal policy, but also structural.
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BIS view on limits of macroprudential policy (Caruana, 2016)
• Persistently low interest rates in the core advanced economies
have spilled over to other economies less affected by the crisis
through various channels:
• spillovers can fuel the build-up of financial imbalances in the
receiving economies…rapidly rising property prices, expanding
credit and increasing indebtedness, including in foreign currency
debt, point to such imbalances.
• Since interest rate determines the universal price of leverage,
monetary policy is a key factor in the financial cycle.
• A holistic approach to macroeconomic and financial stability will
involve a suite of policies: prudential, macroprudential, monetary
and fiscal policies - and no less importantly, structural reforms.
• A holistic approach would call for a monetary policy that
responds more symmetrically to the financial cycle to help
contain financial imbalances.
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Thank you for your attention
Contact:
Financial Stability Department in the CNB:
[email protected]
CNB: Financial Stability Reports, various issues available at http://www.cnb.cz/en/financial_stability/
Jan Frait
Financial Stability Department
Czech National Bank
Na Prikope 28
CZ-11503 Prague
Tel.: +420 2 2441 4430
E-mail: [email protected]
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References
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