Panellists speaking on a Central Banking On Air webinar debate this morning (September 27) stressed the importance of good macro-prudential policy-making in averting future financial crises. But they said the use of innovative, untried policy tools could create unintended consequences.
Bernd Braasch, director, financial stability department of the Deutsche Bundesbank, warned that central banks could be over-ambitious when implementing new tools. "The main criteria to evaluate these instruments… is to what extent and how do they influence the pro-cyclicality and stability of the market as a whole," said Braasch. "We do not have such a long-term experience with these effects."
Véronique Ormezzano, global head of official institutions coverage at BNP Paribas, shared some of Braasch's concerns. "The sky is the limit in terms of imagination with new tools," she said. "Everybody needs to be humble… this is very much experimental."
Even policies that are more widely understood, such as extra capital requirements and the counter-cyclical buffer under the Basel III framework, carried risks, the panellists said. Philip Davis, an associate professor at Brunel University and a macro-prudential policy adviser to the International Monetary Fund, said raising overall capital requirements could be detrimental to growth. As an alternative he suggested targeted capital requirements allowed policy-makers to "impose rigour" on certain sectors of the economy without increasing requirements overall.
Regarding the counter-cyclical capital buffer, Ormezzano said the idea was sound in theory, but increasing the capital ratio created problems for banks. Reducing the size of balance sheets would be pro-cyclical, she said, while raising capital from retained earnings or investors would be difficult during a crisis.
She added policy-makers may have asymmetric incentives when adjusting the buffer. "I can see how regulators might increase the buffer in boom times, but I see much less incentive to reduce the buffer when the boom ends," she said.
Davis raised a further issue with policy-makers' incentives. "When you impose a policy the costs are immediate, but the benefits are in preventing future crises. So we immediately have a political economy problem," he said.
The panellists noted the effects would differ based on the policy regime – the Bank of England will be fully responsible for setting macro-prudential policy, while the Bundesbank only makes recommendations, for example.
The panellists also discussed the possible tension between the objectives of monetary and macro-prudential policies. Braasch stressed that macro-prudential policy should not be the first priority for central banks. "One thing should be clear: the main objective is price stability," he said.
Ormezzano suggested, however, that the trade-off could be lessened if there was co-ordination between macro-prudential and monetary policy-makers. "That could help central banks to be a little more conventional in the way they implement monetary policy," she said.
Despite the challenges, the panellists were positive about the ability of central banks and prudential supervisors to prevent future crises. "I am hopeful that so long as there is a dynamic approach… we can do better next time," Davis said.
Ormezzano expressed a similar sentiment: "So far, central banks have been recognised as having been extremely proactive. Overall, they have played a critical role."
The webinar, ‘Will New Macro-Prudential Policies Work?' was the fourth in a series for this year.