From tapering to preventive policy

At the start of the tapering process in the United States, it is necessary to anticipate what instruments may be used in the next phase. This note makes a strong case for preventive use of macroprudential tools to complement the Basel III buffer approach along the credit cycle. Instruments need to be recalibrated to check evolving risk incentives and regulatory arbitrage. Timely tightening ahead of visible distress will meet fierce opposition and is likely to force delays. To address this tension and avoid forbearance, policymakers should initially prioritise low adjustment cost instruments, to activate upon early warnings rather than in response to shocks. These would minimise resistance, yet provide an immediate effect on risk incentives. Flexible instruments may also be used to adjust the speed of transition towards more robust standards, such as future capital and stable funding norms.