How do monetary, micro- and macroprudential policies interact? Take-aways from an Austrian National Bank workshop

The global financial crisis provoked a wholesale reassessment of prudential policy and the framework within which it is conducted, and also led central banks to adopt very accommodate stances using an array of unconventional instruments. The Austrian National Bank (OeNB) workshop was an occasion to look back on the choices made in the wake of the crisis—especially choices about institutional structure, governance, and the coordination of policies—and to reflect on how our understanding of the interaction among monetary, microprudential, and macroprudential policies has evolved over the subsequent ten years. (Other financial sector policies such as consumer protection are important but less closely related to central banking.)

One reaction to the financial crisis was to give new prominence to macroprudential oversight, concerned with the stability of the (financial) system as a whole. New institutions were established and tools were created or adapted. (Prior to the crisis, macroprudential concerns centered on dollarization and to some extent rapid credit growth in emerging market countries.)

Another reaction, seen in many countries, was to widen the central bank mandate to encompass more responsibility for prudential and also crisis management functions. The wider mandate reflects the pivotal role played by central banks in handling the crisis.


In Europe, the political will was found to strengthen and partially integrate the financial system, through the establishment of the Banking Union, with its Single Supervisory Mechanisms and Single Resolution Mechanism; the European Systemic Risk Board; and the European supervisory authorities such as the European Banking Authority. In keeping with the history of the European project, a crisis was used to overcome entrenched national interests, but the resulting structures are complex and not fully tested.

As discussed at the workshop, no one model for the allocation of responsibilities for monetary, micro-, and macroprudential policy formulation and implementation is clearly superior. The evidence presented suggests that central banks with prudential responsibilities have not been distracted from their core price stability mandate, at least in the recent past. Output stability in those countries has, if anything, been lower than in countries with dispersed responsibilities. But no institutional arrangement seems to make a country immune to the risk of financial crisis.

Workshop panelists saw some complementarities among policies and capacities in the three areas. Most obviously, macroprudential policy deploys traditional microprudential tools, such as capital requirements, besides others. Within the Banking Union in the post-crisis era, macroprudential policy has been used to dampen overly rapid asset price rises in some markets, apparently without undermining the overall accommodative monetary policy stance. Central banks tend to have macroeconomic data and expertise valuable in formulating macroprudential policy, but they also need to be aware of and understand any banking sector distress that may affect monetary transmission.

However, panelists pointed out the natural reluctance on the part of government to give very wide powers to a single, independent and “technocratic” institution, be that a central bank or a prudential authority. Especially macro- and microprudential decisions can have visible distributional and even fiscal effects, and are thus intensely political. Moreover, assigning many mandates to one institution may create a “tail risk” of conflict and confusion among them.

My intervention focused on how the interaction of monetary, micro- and macroprudential policies is most intense, and perhaps most prone to generating conflict, in times of financial crisis. Then momentous decisions in all three areas have to be taken in a hurry and on the basis of very imperfect information, and the macro-financial consequences of government action or inaction can be far reaching. Decision- making and governance arrangements will be severely tested. What functions well in normal times but may become dysfunctional when pressures mount, for example, because claimants on failing banks will lobby hard to be bailed out. Governance arrangements should be designed to be effective in “normal” times (for example, to limit regulatory capture or undue politicization) and in crisis times (for example, to facilitate taking early intervention measures and not bailing out insolvent institutions).

Panelists agreed that a major challenge, at the national and even more so at the European level, is to establish crisis management mechanisms that yield appropriate monetary, micro- and macroprudential policies under those circumstances. Only when the mechanisms recently put in place are tested by events will we be able to judge whether this challenge has been met.

Link:

https://www.oenb.at/en/Monetary-Policy/Research/workshops/2019-12-02-monetary-micro-and-macroprudential-policies.html


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Danial Hardy (Visiting Academic, EuPEP, St Antony's College, Oxford)