1 Counter-Cyclical Macro-Prudential Measures? By C.A.E. Goodhart Problem 1: Not capture, but common mindset: (a)Macro-economic stability (the Great Moderation), plus sufficient capital (Basel II), would always provide access to funding liquidity from global efficient wholesale markets. (b)Over USA as a whole housing prices would never fall significantly.

2 Problem 2: Definition of capital whittled away by clever use of hybridisation, so TCE often less than 2% of RWA. Leverage > 50x in major European banks. Problem 3: Basel II and mark-to-market accounting makes regulation procyclical. Result: Most everyone, markets and regulators, thought that banking had never been safer than in June/July 2007, on edge of precipice.

3 Need to prevent regulation exacerbating cycles. Role of regulation is to “take away the punch bowl just when the party gets going”, McChesney Martin. Not a popular activity; involves bucking the market. The market, not the regulatory regime, will normally be the constraint in a downturn. Regulators superfluous then. How can a regulator justify steps to check a boom? Pillar 2 of Basel II was never used.

4 Need for rules to give regulators backbone. Discretion will rarely be used, even though Basel III proposes up to 2½% additional. But question of which rules:- C. Borio (BIS): Credit expansion (but coverage and timing) R. Barrell (NIESR): Housing prices and current account R. Repullo: GDP relative to trend Arguments among academics mean that no measures/indicators regarded as robust. Therefore will be left to discretion. I would much prefer ‘comply or explain’. It would change the incentives.

5 Conclusion: Counter-cyclical macro-prudential regulation is too difficult; will rarely be used. Instead, the general level of regulation will be raised, and some direct constraints imposed. May lead to shifts of business outside the banking sector. Regulation will not, and cannot, prevent crises, but may mitigate their virulence.