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A macro‐prudential perspective of financial regulation

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  • Tristan Nguyen

Abstract

Purpose - In the recent financial crisis, many observers have assigned monetary policy a central role in the crisis. Specifically, they claim that excessively easy monetary policy by the Federal Reserve in the first half of the decade helped to cause a bubble in housing prices in the USA. The purpose of this paper is to analyze the role of monetary policy within the regulatory frameworks of financial markets. Design/methodology/approach - The authors show within a macroeconomic framework a possible trade‐off between price stability and financial stability by differentiating between a technology‐driven bubble and an animal spirit bubble. In their conclusion: if there is a trade‐off between price stability and financial stability, the central bank will have to make a choice between the two objectives. In that case, the question arises of which of the two objectives should take precedence: price stability or financial stability? Findings - From this analysis, the authors conclude that a central bank which uses a lexicographic ordering favoring price stability over other objectives is likely to fuel the boom inadvertently (in the case of a technology‐driven bubble) or will decide to do nothing (in the case of an animal spirit bubble) allowing a process of excessive credit creation. The latter seems to be what happened between 2003 and 2008. Practical implications - If one wants to reduce the likelihood of future major financial busts, it must be accepted that the central banks (especially the Fed and the ECB) cannot only be responsible for price stability. Maintaining financial stability by preventing excesses in financial markets should be an equally important objective. Originality/value - The paper gives a new perspective on the role of monetary policy within the regulatory framework. With this macroeconomic framework, the authors are able to show possible trade‐offs between price stability and financial stability. The micro‐ and macro‐prudential approach of this paper is a useful contribution to the discussion about regulatory reforms of financial markets.

Suggested Citation

  • Tristan Nguyen, 2011. "A macro‐prudential perspective of financial regulation," Journal of Financial Regulation and Compliance, Emerald Group Publishing Limited, vol. 19(3), pages 289-297, July.
    • Handle: RePEc:eme:jfrcpp:v:19:y:2011:i:3:p:289-297
    DOI: 10.1108/13581981111147900
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    References listed on IDEAS

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    1. Claudio Borio & Mathias Drehmann, 2011. "Toward an Operational Framework for Financial Stability: “Fuzzy” Measurement and Its Consequences," Central Banking, Analysis, and Economic Policies Book Series, in: Rodrigo Alfaro (ed.),Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 4, pages 063-123, Central Bank of Chile.
    2. Olivier Blanchard & Giovanni Dell'Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 199-215, September.
    3. Erlend Nier, 2009. "Financial Stability Frameworks and the Role of Central Banks: Lessons From the Crisis," IMF Working Papers 2009/070, International Monetary Fund.
    4. Kannan Prakash & Rabanal Pau & Scott Alasdair M., 2012. "Monetary and Macroprudential Policy Rules in a Model with House Price Booms," The B.E. Journal of Macroeconomics, De Gruyter, vol. 12(1), pages 1-44, June.
    5. Janet L. Yellen, 2009. "A Minsky meltdown: lessons for central bankers," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may1.
    6. Paul De Grauwe & Daniel Gros, 2009. "A New Two-Pillar Strategy for the ECB," CESifo Working Paper Series 2818, CESifo.
    7. Joanne Hindle, 2009. "The future of regulation," Journal of Financial Regulation and Compliance, Emerald Group Publishing Limited, vol. 17(4), pages 415-426, November.
    8. Otmar Issing, 2009. "In search of monetary stability: the evolution of monetary policy," BIS Working Papers 273, Bank for International Settlements.
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    1. Roszkowska Paulina & Prorokowski Łukasz, 2013. "Model of Financial Crisis Contagion: A Survey-based Simulation by Means of the Modified Kaplan-Meier Survival Plots," Folia Oeconomica Stetinensia, Sciendo, vol. 13(1), pages 22-55, December.

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