IDEAS home Printed from https://ideas.repec.org/p/bre/wpaper/545.html
   My bibliography  Save this paper

G20 and macroprudential policy

Author

Listed:
  • Stefan Gerlach

Abstract

At the upcoming G20 meetings the issue what can be done to avoid a repetition of the current deep financialcrisis will again be debated. Much attention and criticism will be directed to central banks. That is unavoidable: central banks must never again permit the development of financial imbalances that are large enough to lead to the collapse of major parts of the financial system when they unwind. In the future, policy makers must â??lean against the windâ?? and tighten financial conditions if they perceive that imbalances are forming, even if there is little hard data to rely on. And they must be mindful that the costs of acting too late can dwarf those of acting too early. But monetary policy is not the best tool to use for this purpose. Interest rates have simply too blunt effects to deal with financial imbalances, which are typically localised in particular market segments, institutions or, inthe euro area, countries. To slow down the growth of such imbalances, interest rates would have to be raised by implausibly large amounts which would depress economic activity overall and would hurt other segmentsof the economy.Furthermore, within the euro area it is not desirable to use monetary policy to deal with financial imbalances that only affect some countries. While tighter monetary policy might have been useful to limit housingbubbles in Spain or Ireland, it would have made for an even weaker housing market in Germany. Of course, this is well-known to policy makers and precisely the reason why so much time and effort is being spent ondeveloping macroprudential tools â?? non-interest rate tools â?? that can be used to constrain financial activity and prevent bubbles from forming. This important process has just started and much work remains to bedone. To give it additional impetus, the G20 must focus squarely on it. What would a new macroprudential regime look like? It will have six important characteristics. First, the new regime must be international in scope. This is why the G20â??s attention is crucial. One common unintended consequence of regulation is that financial activity simply shifts to financial centres with a moreliberal regime, as evidenced most famously by Regulation Q in the US that led to the establishment of the euro dollar market in London in the 1960s. Of course, one could argue that if risky financial activities move abroad,they are somebody elseâ??s problem. But in the modern day, financial markets are closely integrated across the world and a crisis in one country can spread globally in little time. Thus, regulation must be international. Inturn, this implies that international agreement must be reached and that differences, such as those regarding hedge funds, must be overcome. Second, it must have a broad coverage and include all institutions that are highly leveraged or engaged in maturity transformation. One important factor that led to the adoption of the low-regulation regime thatcreated the conditions for the crisis was that during the tightly controlled regime of the 1970s firms avoided regulation by shifting financial activities to the unregulated sector. To prevent this from happening again, thenew regime must not focus solely on deposit-taking institutions but cover as many financial institutions as possible. Third, macroprudential policy must be transparent and predictable. To limit the procyclicality of the financial system, the macroprudential policy instruments will be varied over time. In financial booms and busts policymakers will thus rely on those instruments that they feel will most effectively deal with the precise imbalances diagnosed. To avoid that such policy changes trigger unexpected and therefore potentially harmful swings in asset prices, policy must be predictable. That requires transparency about the reasons for policy changes and the authoritiesâ?? assessment of financial conditions. Fourth, there is no single instrument that can be relied upon to ensure financial stability, and the macroprudential regime must make use of a whole range of available tools, even though some have shortcomings. Thus, pro-cyclical capital requirements, leverage ratios, loan-to-value ratios and other tools all have a role to play. A pragmatic approach must be taken.Fifth, macroprudential policy must be conducted together with monetary policy. While macroprudential policy, in contrast to interest rate policy, can be focussed on the market segment that raises financial stabilityconcerns, such as real estate lending or lending to hedge funds, both affect the economy in broadly similar ways, and it is therefore important that they are co-ordinated carefully.Sixth, the task of setting macroprudential policy must be determined jointly by representatives from the central bank and all government agencies with responsibility in this area. International cooperation is also essential and attention from the G20 is therefore desirable. Given the close links between monetary and macroprudential policy and the fact that the crisis has shown that the cooperation between central banks and other authorities responsible for financial stability has not always functioned as well as hoped for, it is crucial that the authority for setting macroprudential policy at the national level is vested in one body. At the international level, these bodies must maintain close contacts. Constructing a well-functioning macroprudential regime with a global dimension is no small task. The leadership of the G20 is thereforeessential.

Suggested Citation

  • Stefan Gerlach, 2010. "G20 and macroprudential policy," Working Papers 545, Bruegel.
  • Handle: RePEc:bre:wpaper:545
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    References listed on IDEAS

    as
    1. William Allen & Richhild Moessner, 2010. "Central bank co-operation and international liquidity in the financial crisis of 2008-9," BIS Working Papers 310, Bank for International Settlements.
    2. Yin‐Wong Cheung & Guonan Ma & Robert N. McCauley, 2011. "Renminbising China'S Foreign Assets," Pacific Economic Review, Wiley Blackwell, vol. 16(1), pages 1-17, February.
    3. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
    4. Benassy-Quere, Agnes & Coeure, Benoit & Mignon, Valerie, 2006. "On the identification of de facto currency pegs," Journal of the Japanese and International Economies, Elsevier, vol. 20(1), pages 112-127, March.
    5. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear of Floating," The Quarterly Journal of Economics, Oxford University Press, pages 379-408.
    6. Reinhart, Carmen & Kaminsky, Graciela, 2000. "Las crisis gemelas: las causas de los problemas bancarios y de balanza de pagos
      [The twin crises: Te causes of banking and balance of payments problems]
      ," MPRA Paper 13842, University Library of Munich, Germany.
    7. Caballero, Ricardo J & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2006. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," Center for International and Development Economics Research, Working Paper Series qt7xc0g8mm, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
    8. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2008. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," American Economic Review, American Economic Association, vol. 98(1), pages 358-393, March.
    9. Barry Eichengreen & Marc Flandreau, 2008. "The Rise and Fall of the Dollar, or When Did the Dollar Replace Sterling as the Leading International Currency?," NBER Working Papers 14154, National Bureau of Economic Research, Inc.
    10. Frederic S. Miskin & Klaus Schmidt-Hebbel, 2007. "Does Inflation Targeting Make a Difference?," Central Banking, Analysis, and Economic Policies Book Series,in: Frederic S. Miskin & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Monetary Policy under Inflation Targeting, edition 1, volume 11, chapter 9, pages 291-372 Central Bank of Chile.
    11. Barry Eichengreen, 1987. "Hegemonic Stability Theories of the International Monetary System," NBER Working Papers 2193, National Bureau of Economic Research, Inc.
    12. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
    13. Dobson, Wendy & Masson, Paul R., 2009. "Will the renminbi become a world currency?," China Economic Review, Elsevier, vol. 20(1), pages 124-135, March.
    14. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear of Floating," The Quarterly Journal of Economics, Oxford University Press, vol. 117(2), pages 379-408.
    15. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    16. Christian Thimann, 2008. "Global Roles of Currencies," International Finance, Wiley Blackwell, vol. 11(3), pages 211-245, December.
    17. Rose, Andrew K., 2007. "A stable international monetary system emerges: Inflation targeting is Bretton Woods, reversed," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 663-681, September.
    18. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2004. "The revived Bretton Woods system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(4), pages 307-313.
    19. William R. White, 2006. "Is price stability enough?," BIS Working Papers 205, Bank for International Settlements.
    20. Dorrucci, Ettore & McKay, Julie, 2011. "The international monetary system after the financial crisis," Occasional Paper Series 123, European Central Bank.
    21. Edwin M. Truman, 2010. "Strengthening IMF Surveillance: A Comprehensive Proposal," Policy Briefs PB10-29, Peterson Institute for International Economics.
    22. Menzie Chinn & Jeffrey Frankel, 2008. "Why the Euro Will Rival the Dollar," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 55(3), pages 255-278, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bre:wpaper:545. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Bruegel). General contact details of provider: http://edirc.repec.org/data/bruegbe.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.