1 Macro-Prudential Policy: How to Design for Success By C.A.E. Goodhart

2 Introduction Recent events have underscored Hy Minsky’s analysis that the achievement of price stability does not entail, and can even put at greater risk, the maintenance of financial stability. The Central Bank has responsibility for both; indeed historically the latter had precedence, (the Gold Standard maintaining price stability).

3 The Rationale of Macro-Pru With two separate objectives, the Tinbergen principle would suggest two differing instruments, hence macro-pru. But how does macro-pru differ from interest rate policy; do not both operate on the cost and availability of finance? Macro-pru, in the form of capital requirements, margins, etc., needs to be much more directional and specific (granular) in relation to the location and use of funds, (e.g. mortgages in London, but not in N.E.). Specific constraints are much more porous; ‘interest rates fill all cracks’. Also directional policies have more obvious distributional effects and so may be more resented.

4 Can Macro-Pru Work? Having a contra-cyclical macro-pru policy is a splendid idea in theory, but will it work in practice? Most difficult in a bust after a financial crisis, since latter demonstrated that capital and liquidity were too low. So Micro-pru strongly contractionary; more capital, more liquid assets, deleveraging. How can one get any expansionary macro-pru at the same time? Distinguish requirements on margin (and on new assets) from those on average (old assets). FLS, HtB. If there was, as there should have been, a ladder of sanctions, the penalty for dropping down a rung, or two, could be lessened. Forebearance can be beneficial; ‘temper the wind to the shorn lamb’.

5 Macro-Pru in the Boom In the boom the objectives of micro and macro-pru work together. But might macro-pru then have an upwards ratchet, (raised in the boom, not lowered in the bust), until limited by avoidance? On the other hand will macro-pru be applied sufficiently aggressively, o.a. i)Uncertainty about sustainability; ii)Political opposition (housing); iii)Limited experience, hence caution; iv)Asset price expectations in a bubble. N.B. FPC did not initially even ask for powers to vary LTV and LTI. HtB now forcing them to take a position.

6 “..it is almost inevitable that the policy actions required to ensure that crisis conditions do not occur will be unpopular. It is hard to visualize now how pre 2007 any authority which had not been explicitly tasked to do so, could have stood up simultaneously to the politicians wanting continued growth, the industry wanting to maximize profits and the public wanting to maximize their spend through increasing levels of debt. This of course strongly suggests that, to meet this objective, you need a body which is fully independent from the broader political process, both as to analysis and desired policy response.” Sir Andrew Large, (December 2013)

7 The Structure of Macro-Pru Far from conflicting with monetary policy, the adoption of macro-pru relaxes a constraint on monetary policy (Sweden, UK 2014). Best done by Central Bank, but subject to separate considerations, analyses, forecasts. MPC and FPC appropriate. How about micro and macro; FSOC (US), Sweden? No clear best approach.

8 How to make Macro-Pru Successful? Precommitment to quantitative rules, Comply or explain. Needs political support (HtB). Ladder of sanctions, with time/state varying penalties. Worries May damage independence/credibility of CB. May not be used aggressively enough. Difficult/impossible to use in a bust. Works in theory, but not in practice?