Macroprudential policy is a complement to microprudential policy and it interacts with other types of public policy that have an impact on systemic financial stability. Indeed, prudential regulation, as carried out in the past, also had some macroprudential aspects, and the recent crisis has reinforced this focus; hence, a clear separation between “micro” and “macro” prudential, if useful conceptually, is difficult to delineate in practice. Moreover, no matter how different policy mandates are structured, financial stability tends to be a common responsibility, reflecting the far reaching consequences of financial crises. This calls for coordination across policies, to ensure that systemic risk is comprehensively addressed. Equally important, macroprudential policy is no substitute for sound policies more broadly, including, in particular, strong prudential regulation and supervision, and sound macroeconomic policies. Operational independence in other policy areas, including monetary and microprudential policy, should not be undermined in the name of macroprudential policy.
To be effective, institutional arrangements for macroprudential policy need to ensure a policymaker’s ability and willingness to act—including clear mandates; control over macroprudential instruments that are commensurate with those mandates; arrangements that safeguard operational independence; and provisions to ensure accountability, supported by transparency and clear communication of decisions and decision-making processes.--INTERNATIONAL MONETARY FUND (2011) "Macroprudential Policy: An Organizing Framework [Emphasis added.--ES]
After the stagflation of the 1970s, the conventional wisdom in the 1980/90s trough the turn of the century was that central banks should be made as independent as possible from political control; this conventional wisdom was translated in high degree of operational independence in most advanced economies (see here for useful distinctions and history). Let's stipulate, for the sake of argument, that if keeping inflation low is the only/main monetary policy objective that such independence makes sense and is supported by sound empirical evidence. Even so, the two decade experiment with central bank independence has to be judged a failure, and it is distressing that the IMF is unwilling to discuss the issues frankly.
For, as the most recent financial crisis reminded us, Central Bankers have more roles than fighting inflation. They have considerable responsibility for the health of the financial system as a whole (now known as systemic risk), and they bear some non-trivial responsibility for preventing financial bubbles*--the clean-up of which is not just very expensive and painful to the economy, but also has non-trivial distributive consequences. While there is plenty of blame to go around, central banks failed to take the punchbowl away when they could; as recounted before, there was considerable cognitive regulatory capture, reliance on outdated models (which treated mortgages as safe--this mistake was especially clear in the public utterances by the Dutch central bank director, Wellink), and a permissive attitude (enshrined in Basle agreements) toward banks' internal risk modeling (the list is longer). This is not to deny that (a) some central banks acted prudently in the run-up to the great recession [Canada's has been widely praised], and (b) some central banks performed well in the eye of the storm (in my non-expert view Bernanke did so).
Now, one may claim that politically controlled central banks would have performed just as badly. This is by no means obvious. For, while it's clear (let's stipulate) that politicians are sometimes permissive of inflation in order to nudge employment along, even this is not a universal rule given the political clout of pensioners and other people on fixed incomes not to mention creditors, all of whom dislike inflation intensely. Moreover, it is by no means obvious that they would want to risk being held responsible (even retrospectively) for the gigantic financial bail outs we have witnessed. Even if some politicians would have behaved no differently than the central bankers did, it is extremely unlikely, given the varied political conditions and coalitions in different countries/continents, that they would have acted so uniformly mistakenly as the central bankers have done. I am not claiming that politicans always get it right, but the fact of the matter is, when the central bankers screw up, as they did, the central bankers don't pay for their mistakes; it's the taxpayers that do--that is to say, the incentives are, in fact, aligned incorrectly to sustain central bank independence.
It says something of the mistrust of politicians among the intellectual, economic, and financial elite(s) that the argument(s) and observations just sketched are not being discussed more widely. (Undoubtedly I have simplified the situation and maybe I have overlooked something important.) In fact, the IMF report quoted above -- which is supposed to be a technical report not a political report -- goes out of its way to repeatedly insist, on the basis of no empirical evidence whatsoever,** that central bank independence should be sacrosanct. Obviously, if there were robust knowledge that could guide macroprudential and monetary policy, then, perhaps, one could make an argument that rule-following, public spirited experts should be entrusted with independence. But as the IMF report notes, such knowledge is as of yet unavailable. The big picture decisions of managing the financial system are, in fact, political -- because uncertain and distributive in character -- and should be made by politicians, even if some politicians prefer otherwise (so that they can never be blamed). Either way, it is by no means obvious that keeping central bankers independent promotes "accountability."
**The point is made very tactfully by one of the intellectual architects of macroprudential policy, C. Borio:
A key mechanism through which monetary policy operates is precisely by influencing risk perceptions and risk appetite – the socalled ‘risk-taking channel’ (Rajan 2005, Adrian and Shin 2010, Borio and Zhu 2012). Like macroprudential measures, it also critically influences the incentive and ability to borrow. But the impact of monetary policy is more pervasive – it sets the universal price of leverage in a given currency (e.g. Borio and Drehmann 2011, Stein 2013). generally, there is a tension in employing the two policies in opposite directions: it is a bit like driving by pressing on the accelerator and brake simultaneously – not exactly what is normally recommended. Macroprudential frameworks must be part of the answer, but they cannot be the whole answer. (Borio, 2014, pp. 40-41).
*The main argument is on p. 37: "Central banks also have strong institutional incentives to ensure the effectiveness of macroprudential policies, because, if macroprudential policies are ineffective, this is costly for central banks." Even if taken at face value -- and it is not obvious that central bansk really encur costs here --, the argument is fallacious: ineffective macropprudential policies are not costly to central bankers (even if they are costly to central banks). It astounding to see trained economists ignore individual incentives when it suits them.
Comments