Taking Away the Punch Bowl: Institutional Settings and Macroprudential Activity

• In Event: Central Banks and Their Objectives

Abstract

The post-global financial crisis period has been marked by the shift from a micro- to a macroprudential perspective to regulate financial systems and prevent future crises. As a result, governments assigned new mandates of analysis and management of financial stability to dedicated authorities, with the explicit objective to mitigate vulnerabilities associated with financial cycles. This surprising intellectual consensus which has built around the concept of macroprudential policy among policymakers has thus been characterized by some political economists as an “ideational shift”. This renewed focus on the importance of “the financial cycle” is backed by a large body of evidence concluding that excessive credit cycles have consistently been at the origin of most systemic banking crises over the past 150 years, hence rendering financial crises almost “predictable” - and thus avoidable.

This wide consensus on the need for macroprudential policy to address excessive risk-taking stands in sharp contrast to the unsettled debate on the most appropriate institutional arrangement for the conduct of such new policy area. In fact, and unlike monetary policy for which a uniform institutional framework with independent central banks at its core has been gradually adopted around the world, there exists a surprisingly wide heterogeneity of macroprudential arrangements across countries.

This paper argues that this is due to the scarcity of research on the inherent politics of macroprudential policy. It first argues that the relations between governments and macroprudential authorities have to take the center stage of the analysis due, on the one hand, to the possibility of short-term political interference in the conduct of macroprudential policy, and on the other to the political and distributional consequences of a number of macroprudential tools calling for democratic accountability.

Along the first dimension, households’ preferences for credit expansion and their resulting electoral consequences, the role of housing in growth models and the size of the construction sector, as well as the time inconsistency between financial and electoral cycles would predict a high resistance of governments to macroprudential tightening. These objectives may often enter in conflict with macroprudential objectives and hence granting more autonomy to the macroprudential authority vis a vis the government should limit short-term manipulation of credit cycles for electoral benefits. Along the second dimension, the inherently political, visible and distributional aspects of many macro-prudential tools may, on the contrary, discourage autonomous authorities like the central bank to act, for fear of negative spillovers on its monetary policy mandates. I illustrate these dynamics through two detailed case studies of Ireland and Sweden.

These hypotheses are then tested empirically, leveraging on a newly computed index of macroprudential autonomy and a detailed dataset of macroprudential adjustments for 50 countries. I find that delegating macroprudential policy to independent central banks surprisingly diminish the likelihood of tightening macroprudential policy in the boom phase. This is especially the case for more visible and political tools such as LTV caps relative to more general capital-based tools, and for central banks that have monetary policy powers.

Overall, these findings provide support for the hypothesis that central banks may be reluctant to engage in “political-charged” tools for fear of negative spillovers on its monetary policy conduct and that democratic backing and government involvement may be necessary for tools directly impacting household borrowing.

Author

• Etienne Lepers