RBA and Macroprudential

In a speech “Has the Way We Look at Financial Stability Changed Since the Global Financial Crisis?“, Michele Bullock, RBA Assistant Governor (Financial System) discussed the RBA’s perspective on macroprudential.

Referring to APRA’s 2014 “tightening” of mortgage lending, she says that whilst borrowers risks may have lowered, “the initial effects on credit and some other indicators we use to assess risk may fade over time”.

Agreed. It is clear that the regulators have not done enough to tame housing credit growth, conflicted as they are between seeing housing momentum as a replacement for the fading mining boom on one side, and the risks to households, their high levels of debt, and broader financial stability on the other. Actually, we think the Council of Financial Regulators (that shadowy body, chaired by the RBA, and including APRA, ASIC and Treasury) has failed to manage the fundamentals in the past few years. Did they not see the risks, or did they choose to ignore them? In that light, Bullock’s comments have a hollow ring!

Post-GFC, there is now more acceptance of the need to take action when system-wide risks are rising. This is reflected in the increasing use of what are commonly known as macroprudential policies.

As my colleagues David Orsmond and Fiona Price note in a Bulletin article in December 2016, there is no universally accepted definition of macroprudential policy. They define it as ‘the use of prudential actions to contain risks that, if realised, could have widespread implications for the financial system as a whole as well as the real economy.’ They also note that the use of such tools has increased in a number of countries post-GFC.

In Australia, we see macroprudential policy as part and parcel of the financial stability framework. As we have set out on other occasions, the essence of macroprudential policy is that prudential supervisors recognise potential system-wide risks in their supervision of individual institutions and react accordingly.[3] APRA can and does take an active supervisory stance, modifying the intensity of its prudential supervision as it sees fit to address institution-specific risks, sectoral risks or overall systemic risk. A recent example might help to illustrate this.

In 2014, the Australian regulators took the view that risks were building in the residential housing market that warranted attention. There was very strong demand for residential housing loans, particularly by investors. Price competition in the mortgage market had intensified and discounts on advertised variable rates were common. There also seemed to be a relaxation in non-price lending terms. The share of new loans that were interest only was drifting up and the growth of lending for investment properties was accelerating. Unsurprisingly in this environment, the growth in housing prices was strong, particularly in Melbourne and Sydney.

The regulators judged that more targeted action was needed to address the risks – to put a bit of sand in the gears. So APRA tightened a number of aspects of its supervision. It indicated that it would be alert to annual growth in a bank’s investor housing lending above a benchmark of 10 per cent. It also set some more prescriptive guidelines for serviceability assessments and intensified its scrutiny of lending practices. ASIC also undertook a review of lending with a focus on whether lenders were complying with responsible lending obligations.

There is no doubt that the actions did address some of the risks. Nevertheless, the early experience suggests that, while the resilience of both borrowers and lenders has no doubt improved, the initial effects on credit and some other indicators we use to assess risk may fade over time. We are continuing to monitor their ongoing effects and are prepared to do more if needed.

Where to from here? With the GFC close to 10 years ago now and a substantial amount of regulatory reform having been undertaken, the focus is turning to implementation and taking stock of the effectiveness of the reforms. This is reflected in the FSB’s current agenda. But there is also some thinking to be done about how monetary policy considerations should factor in financial stability issues, and the role that macroprudential policies might play in addressing system-wide risks in a low interest rate environment.

In conclusion, I would like to return to the question I posed at the beginning of this talk, and in fact the question I posed myself when I first came into this area a few months ago – has the way we look at financial stability changed since the GFC? While the basic way we look at financial stability has not changed, experience with the GFC reinforced the need to focus on system-wide issues. We need to spend time analysing them and thinking about whether policy responses might be required. We are still learning how best to do this.

Investors Boom, First Time Buyers Crash

The ABS released their Housing Finance data today, showing the flows of loans in January 2017. Those following the blog will not be surprised to see investor loans growing strongly, whilst first time buyers fell away. The trajectory has been so clear for several months now, and the regulator – APRA – has just not been effective in cooling things down.  Investor demand remains strong, based on our surveys. Half of loans were for investment purposes, net of refinance, and the total book grew 0.4%.

In January, $33.3 billion in home loans were written up 1.1%, of which $6.4 billion were refinancing of existing loans, $13.6 billion owner occupied loans and $13.5 billion investor loans, up 1.9%.  These are trend readings which iron out the worst of the monthly swings.

Looking at individual movements, momentum was strong, very strong across the investor categories, whilst the only category in owner occupied lending land was new dwellings.  Construction for investment purposes was up around 5% on the previous month.

Stripping out refinance, half of new lending was for investment purposes.

First time buyers fell 20% in the month, whilst using the DFA surveys, we detected a further rise in first time buyers going to the investment sector, up 5% in the month.

Total first time buyer activity fell, highlighting the affordability issues.

In original terms, total loan stock was higher, up 0.4% to $1.54 trillion.

Looking at the movements across lender types, we see a bigger upswing from credit unions and building societies, compared with the banks, across both owner occupied and investment loans. Perhaps as banks tighten their lending criteria, some borrowers are going to smaller lenders, as well as non-banks.

We think APRA should immediately impose a lower speed limit on investor loans but also apply other macro-prudential measures.  At very least they should be imposing a counter-cyclical buffer charge on investment lending, relative to owner occupied loans, as the relative risks are significantly higher in a down turn.

The budget has to address investment housing with a focus on trimming capital gain and negative gearing perks.  The current settings will drive household debt and home prices significantly higher again.

Macroprudential – How To Do It Right

Brilliant speech from Alex Brazier UK MPC member on macroprudential “How to: MACROPRU. 5 principles for macroprudential policy“.

He argues that whilst macroprudential policy regimes are the child of the financial crisis and is now part of the framework of economic policy in the UK, if you ask ten economists what precisely macroprudential policy is, you’re likely to get ten different answers. He presents five guiding principles.

There are some highly relevant points here, which I believe the RBA and APRA must take on board. I summarise the main points in his speech, but I recommend reading the whole thing: This is genuinely important! In particular, note the limitation on relying on lifting bank capital alone.

First, macroprudential policy may seem to be about regulating finance and the financial system but its ultimate objective the real economy. In a crisis, the financial system may be impacted by events in the economy – for example credit dries up, lenders are not matched with borrowers. Risks can no longer be shared. Companies and households must protect themselves. And in the limit, payments and transactions can’t take place. Economic activity grinds to a halt. These are the amplifiers that turn downturns into disasters; disasters that in the past have cost around 75% of GDP: £21,000 for every person in this country. So the job of macroprudential policy is to protect the real economy from the financial system, by protecting the financial system from the real economy. It is to ensure the system has the capacity to absorb bad economic news, so it doesn’t unduly amplify it.

Second, the calibration of macroprudential should address scenarios, not try to predict the future but look at “well, what if they do; how bad could it be?” In 2007, he says it was a failure to apply economics to the right question. There was too much reliance on recent historical precedent; on this time being different. And, even more dangerously, they relied on market measures of risk; indicators that often point to risks being at their lowest when risks are actually at their highest.

The re-focussing of economic research since the crisis has supported us in that. It has established, for example, how far: Recessions that follow credit booms are typically deeper and longer-lasting than others; Over-indebted borrowers contract aggregate demand as they deleverage; While they have high levels of debt, households are vulnerable to the unexpected. They cut back spending more sharply as incomes and house prices fall, amplifying any downturn; Distressed sales of homes drive house prices down; Reliance on foreign capital inflows can expose the economy to global risks; And credit booms overseas can translate to crises at home.

When all appears bright – as real estate prices rise, credit flows, foreign capital inflows increase, and the last thing on people’s minds is a downturn – our stress scenarios get tougher.

Third, feedback loops within the system mean that the entities in the system can be individually resilient, but still collectively overwhelmed by the stress scenario.

These are the feedback loops that helped to turn around $300 bn of subprime mortgage-related losses into well over $2.5 trillion of potential write-downs in the global banking sector within a year. Loops created by firesales of assets into illiquid markets, driving down market prices, forcing others to mark down the value of their holdings. This type of loop will be most aggressive when the fire-seller is funded through short-term debt. As asset prices fall, there is the threat of needing to repay that debt. But even financial companies that are completely safe in their own right, with little leverage, and making no promise that investors will get their money back, can contribute to these loops.

The rapid growth of open-ended investment funds, offering the opportunity to invest in less liquid securities but still to redeem the investment at short notice, has been a sea change in the financial system since the crisis. Assets under management in these funds now account for about 13% of global financial assets. It raises a question about whether end investors, under an ‘illusion of liquidity’ created by the offer of short-notice redemption, are holding more relatively illiquid assets. That matters. This investor behaviour en masse has the potential to create a feedback loop, with falling prices prompting redemptions, driving asset sales and further falls in prices.

And in a few cases, that loop can be reinforced by advantages to redeeming your investment first. Macroprudential policy must move – and is moving – beyond the core banking system.

Fourth, prevention is better than cure.

Having calibrated the economic stress and applied it to the system, it’s a question of building the necessary resilience into it. The results have been transformative. A system that could absorb losses of only 4% of (risk weighted) assets before the crisis now has equity of 13.5% and is on track to have overall loss absorbing capacity of around 28%. Our stress tests show that it could absorb a synchronised recession as deep as the financial crisis.

And if signals emerge that what could happen to the economy is getting worse, or the feedback loops in the system that would be set in motion are strengthening, we will go further.

But bank capital is not always the best tool to use to strengthen the system and is almost certainly not best used in isolation.

We have applied that principle in the mortgage market. Alongside capitalising banks to withstand a deep downturn in the housing market, we have put guards in place against looser lending standards: A limit on mortgage lending at high loan-to-income ratios; And a requirement to test that borrowers can still afford their loan repayments if interest rates rise.

These measures guard against lending standards that make the economy more risky; that make what could happen even worse. Debt overhangs – induced by looser lending standards – drag the economy down when corrected. And before they are, high levels of debt make consumer spending more susceptible to the unexpected. So they guard against lenders being exposed to both the direct risk of riskier individual loans, and the indirect risk of a more fragile economy. This multiplicity of effects means there is uncertainty about precisely how much bank capital would be needed to truly ensure bank resilience as underwriting standards loosen.

A diversified policy is also more comprehensive. It guards against regulatory arbitrage; of lending moving to foreign banks or non-bank parts of the financial system. And by reducing the risk of debt overhangs and high levels of debt, it makes the economy more stable too.

Fifth, It is that fortune favours the bold.

The Financial Policy Committee needs to match its judgements that what could happen has got worse with action to make the system more resilient. Why will that take boldness? Our actions will stop the financial system doing something it might otherwise have chosen to do in its own private interest – there will be opposition. The need to build resilience will often arise when private agents believe the risks are at their lowest. And if we are successful in ensuring the system is resilient, there will be no way of showing the benefits of our actions. We will appear to have been tilting at windmills.

As the memory of the financial crisis fades in the public conscience, making the case for our actions will get harder. Fortunately, we are bolstered by a statutory duty to act and powers to act with. And whether on building bank capital or establishing guards against looser lending standards, we have been willing to act. Just as building resilience takes guts, so too does allowing the strength we’ve put into the system to be drawn on when ‘what could happen’ threatens to become reality. Macroprudential policy must be fully countercyclical; not only tightening as risks build, but also loosening as downturn threatens. Without the confidence that we will do that, expectations of economic downturn will prompt the financial system to become risk averse; to hoard capital; to de-risk; to rein in. To create the very amplifying effects on the real economy we are trying to avoid.

A truly countercyclical approach means banks, for example, know their capital buffers can be depleted as they take impairments; Households can be confident that our rules won’t choke off the refinancing of their mortgage. And insurance companies know their solvency won’t be judged at prices in highly illiquid markets. We must be just as bold in loosening requirements when the economy turns down as we are in tightening them in the upswings. Boldness in the upswing to strengthen the system creates the space to be bold in the downturn and allow that strength to be tested and drawn on. Macroprudential fortune favours the bold.


Are we all macroprudentialists now?

Klaas Knot, President of the Netherlands Bank, spoke at a seminar  “Tomorrow’s banking and how central banks have developed in last 15 Years”. He discussed the role of macroprudential and it’s relationship to monetary policy.

I would like to focus on the increased importance of macroprudential policy for central banks, and elaborate on some of Pentti’s main insights. I want to raise three main points.

My first point is that financial crises have always happened and will always happen. And they do not result from some exogenous, extreme event. Rather, to use Pentti’s words, financial crises can “be interpreted as an extreme manifestation of the financial cycle phenomenon”. By financial cycle we understand systematic patterns over time in the financial system that can have important macroeconomic consequences.

Typically, financial crises are preceded by booms characterized by a combination of intensified financial innovation, robust and widespread appetite for risk, and a favorable economic environment. This favorable environment could for example reflect new growth impulses from technological innovation, international trade, and mobile and volatile international capital flows.

These patterns are indeed not specific to the Global Financial crisis, nor – if we look back in time – to the Great Depression. In fact, the first truly global financial crisis in modern history – the South Sea Bubble of 1720 – originated in England, France and the Netherlands. All key ingredients of an extreme financial cycle gone wrong can be found here. (The famous tulipmania that hit the Dutch Republic in 1636-37 shared some but not all of these elements, and its dynamics can be compared to the dotcom bubble rather than a global financial crisis.)

The burst of the South Sea Bubble followed a period of strong economic growth. The discovery of the economic potential of the New World had led to a shift in global trade towards the triangle that brought manufactured goods to Africa, Africans as slaves to the New World, and commodities to Europe.

There had been rapid innovation in financial engineering, spurred by some form of deregulation. This allowed greater risk sharing and supported exuberance in the financial sector. “Shadow banking” (the English insurance companies and international investors) played a pivotal role. As liquidity stress morphed into solvency problems, the bubble burst with a dramatic international stock market crash.

You can see how the mechanics of this crisis do not differ much from those of the recent Great Financial Crisis, and all other crises traced through history by Charles Kindleberger.

My second point is that there is a consensus that macroprudential policy is an essential toolkit but its effects and transmission channels are still not fully understood. Since the 1930s, policymakers have used prudential means to enhance system-wide financial stability, with a view to limiting macroeconomic costs from financial distress. Some measures taken in the 1930s, 1950s and 1960s to support the domestic financial system and to influence the supply of credit have been viewed as macroprudential tools. Still, when Andrew Crockett pleaded for a macro perspective on prudential policy in 2000, the idea was controversial.

It took the Great Financial Crisis to forge a consensus on the importance of macroprudential policy. As Pentti put it, “Macroprudential policy is needed in addition to other economic policies. It is very important that authorities have also macroprudential instruments available. Now, after the Great Financial Crisis, we have instruments and framework in place.”

But in his usual sharpness Pentti also highlighted the challenges to using macroprudential tools: “the effects of the said instruments are uncertain and second, processes for their usage are unnecessarily complicated. These points are intertwined.”

My third point – and here I would like to elaborate a bit – is that we should not look at macroprudential policy and its effectiveness in isolation. As Pentti argued in a speech last year, it is important to coordinate macroprudential policy and monetary policy. Let me elaborate. The effectiveness of macroprudential policy depends importantly on its interaction with monetary policy. In particular, it hinges on the “side effects” that one policy has on the objectives of the other.

On the one hand, monetary policy can thwart the intentions of macroprudential policy. We all agree that the monetary policy stance affects risk taking of the financial system as a whole.

While macroprudential instruments typically target specific vulnerabilities, monetary policy affects the cost of finance for all financial institutions – including the shadow banking sector. As such, in the words of Jeremy Stein, it “gets in all of the cracks and may reach into corners of the market that supervision and regulation cannot”. This is most evident in a crisis situation, such as the one we are still witnessing in the euro area. Standard and non-standard monetary policies that provide ample liquidity may avoid a collapse of the banking sector. But they can come at the expense of reduced incentives for banks to recapitalize and restructure. They may actually promote the evergreening of  nonperforming loans and regulatory forbearance.

It is argued that targeted macroprudential policies can offset these side effects. But I do not side with this Panglossian view and am afraid that there are limits to what macroprudential tools can achieve in practice. On the other hand, macroprudential policy can thwart the intentions of monetary policy.

Changes in (micro and macro) prudential policy will affect banks’ risk-taking, their financing conditions and balance sheet composition. They will therefore have an impact on the real economy and on price stability. The fact that the ongoing unprecedented monetary policy stimulus does not translate into rapid credit growth in the euro area might then not imply that monetary authorities are not doing enough. Rather, banks are reacting to stricter regulatory rules that have been introduced in the wake of the global financial crisis in an attempt to make the financial system more resilient. These regulatory changes therefore weaken the pass-through of monetary policy measures to the supply of bank credit and, ultimately, to aggregate demand and inflation.

Let me conclude. The claim that “we are all macroprudentialists now” seems to suggest that macroprudential policy has become fashionable.10 Are we then all macroprudentialists? In the spirit of Pentti’s thinking my answer is: Yes – as long as we stay eclectic, pragmatic and flexible. And we take the interactions of monetary and macroprudential policies into account, and coordinate the two policies.


IMF Updates Global Housing Watch

The latest IMF’s Global House Price Index—an average of real house prices across countries—is now almost back to its level before the financial crisis. But there are significant variations, and policy responses.

imf-ghw-nov-2016Developments in the countries that make up the index fall into three clusters. The first cluster—gloom—consists of 18 economies in which house prices fell substantially at the onset of the Great Recession, and have remained on a downward path. The second cluster—bust and boom— consists of 18 economies in which housing markets have rebounded since 2013 after falling sharply during 2007-12. The third cluster—boom—comprises 21 economies in which the drop in house prices in 2007–12 was quite modest and was followed by a quick rebound.

imf-ghw-nov-2016-2Gloom = Brazil, China, Croatia, Cyprus, Finland, France, Greece, Italy, Macedonia, Morocco, Netherlands, Poland, Russia, Serbia, Singapore, Slovenia, Spain, Ukraine.

Bust and boom = Bulgaria, Denmark, Estonia, Germany, Hungary, Iceland, Indonesia, Ireland, Japan, Latvia, Lithuania, Malta, New Zealand, Portugal, South Africa, Thailand, United Kingdom, United States.

Boom = Australia, Austria, Belgium, Canada, Chile, Colombia, Czech Republic, Hong Kong SAR, India, Israel, Kazakhstan, Korea, Malaysia, Mexico, Norway, Peru, Philippines, Slovak Republic, Sweden, Switzerland, Taiwan.

Credit has expanded much faster in the boom group than in the other two.

imf-ghw-nov-2016-3Construction gross value added and residential building permits have stagnated in the gloom group relative to the other two.

imf-ghw-nov-2016-4Among the gloom group:

In China, excess inventory remains high. The IMF assessment points out that for lower-tier cities, where multi-year excess inventory levels are particularly acute, restricting new starts seems warranted, for example by tightening prudential measures on credit to property developers.

In Netherlands, the turnaround in house prices presents an opportunity to remove some of the incentives for excessive leverage—thereby reducing the likelihood and intensity of boom-bust cycles.

There are some concerns about sustainability in a few boom or bust and boom economies:

IMF assessments state that in Belgium, Canada, Luxembourg, Malaysia, Malta, and the United Kingdom, additional macroprudential measures may be needed or considered if housing market vulnerabilities intensify.

In the case of Norway, the IMF assessment points to a substantial overvaluation. In some other cases—Belgium, Korea, and Morocco—the assessments do not find overvaluation.

IMF assessments point to supply constraints as a factor driving house prices in a number of countries where prices have rebounded, including Denmark, Germany, New Zealand, and the United Kingdom.

Many countries have been actively using macroprudential tools to manage house price booms. The main macroprudential tools employed for this purpose are limits on loan-to-value ratios and debt-service-to-income ratios and sectoral capital requirements.

Figure 6 shows that macroprudential policies have been very active in the boom group, followed by gloom group, and bust and boom group.

imf-ghw-nov-2016-6Loan-to-value ratios: Gloom = Brazil, China, Finland, Netherlands, Poland, Serbia, Singapore, Spain. Bust and boom = Estonia, Hungary, Iceland, Indonesia, Latvia, Lithuania, New Zealand, Thailand. Boom = Canada, Chile, Czech Republic, Hong Kong, Israel, Korea, Malaysia, Norway, Philippines, Slovak Republic, Sweden, Taiwan.

Debt-service-to-income ratios: Gloom = Cyprus, Netherlands, Poland, Serbia. Bust and boom = Estonia, Hungary, Ireland, Latvia, United Kingdom, United States. Boom = Canada, Hong Kong, India, Israel, Malaysia, Norway.

Sectoral capital requirements: Gloom = Brazil, Croatia, France, Italy, Poland, Russia, Serbia, Spain. Bust and boom = Bulgaria, Estonia, Iceland, Ireland, Latvia, Lithuania, New Zealand, South Africa, Thailand, United Kingdom, United States. Boom = Australia, Belgium, Colombia, Hong Kong, India, Israel, Korea, Malaysia, Norway, Peru, Slovak Republic, Switzerland, Taiwan.

Longer-Term Challenges for the U.S. Economy

Macroeconomic policy does not have to be confined to monetary policy. Certain fiscal policies, particularly those that increase productivity, can increase the potential of the economy say Fed Vice Chairman Stanley Fischer who discussed the Longer-Term Challenges for the U.S. Economy.



Notwithstanding a number of shocks over the past year, the U.S. economy is performing reasonably well. Job gains have been robust in recent years, and the unemployment rate has declined to 4.9 percent, likely close to its long-run sustainable level. After running at a subdued pace during the first half of the year, gross domestic product growth has picked up in the most recent data, and inflation has been firming toward the Federal Open Market Committee’s 2 percent target.

Although the economy has moved back to the vicinity of the Committee’s employment and inflation targets–suggesting that the cyclical drag on the economy has been greatly reduced, if not largely eliminated–along some dimensions this has not been a happy recovery. Unease with the economy reflects a number of longer-term challenges, challenges that will require a different set of policy tools than those used to address nearer-term cyclical shortfalls in growth. Prominent among these challenges are low equilibrium interest rates and sluggish productivity growth in the United States and abroad. I will first touch on low interest rates before turning to productivity. The federal funds rate and policy rates in other advanced economies remain very low or even negative. Longer-term rates are also low by historical standards, even taking into account the increase of the past two weeks.

Such low interest rates, together with only tepid growth, suggest that the equilibrium interest rate–that is, the rate that neither boosts nor slows the economy–has fallen. Why does this matter? Importantly, low interest rates make the economy more vulnerable to adverse shocks by constraining the ability of monetary policy to combat recessions using conventional interest rate policy–because the effective lower bound on the interest rate means that monetary policy has less room to reduce the interest rate when that becomes necessary. Also, low equilibrium rates could threaten financial stability by encouraging a reach for yield and compressing net interest margins, although it is important to point out that so far we have not seen evidence that low rates have notably increased financial vulnerabilities in the U.S. financial system. More fundamentally, low equilibrium real rates could signal that the economy’s long-run growth prospects are dim.

Why are interest rates so low? In a speech last month, I identified a number of factors that have worked to boost saving, depress investment, or both. Among the factors holding down interest rates is the sluggishness of foreign economic growth. Another is demographics, with saving being higher as a result of an increase in the average age of the U.S. population. Also, investment recently has been weaker than might otherwise be expected, perhaps reflecting uncertainty about longer-run growth prospects, as well as the decline in investment in the energy sector as a result of the fall in the price of oil. Finally, and most important, weak productivity growth has likely pushed down interest rates both by lowering investment, as firms lower their expectations for the marginal return on investment, and by increasing saving, as consumers lower their expectations for income growth and borrow less and/or save more as a consequence.

Understanding the recent weakness of productivity growth is central to addressing the longer-run challenges confronting the economy. Productivity growth over the past decade has been lackluster by post-World War II standards. Output per hour increased only 1-1/4 percent per year, on average, from 2006 to 2015, compared with its long-run average of 2-1/2 percent from 1949 to 2005. This halving of productivity growth, if it were to persist, would have wide-ranging consequences for living standards, wage growth, and economic policy more broadly. A number of explanations have been offered for the decline in productivity growth, including mismeasurement in the official statistics, depressed capital investment, and a falloff in business dynamism, with reality likely reflecting some combination of all of these factors and more.

We should also consider the possibility that weak demand has played a role in holding back productivity growth, although standard economic textbooks generally trace a path from productivity growth to demand rather than vice versa. Chair Yellen recently spoke on the influence of demand on aggregate supply. In her speech, she reviewed a body of literature that suggests that demand conditions can have persistent effects on supply. In most of the literature, these effects are thought to occur through hysteresis in labor markets. But there are likely also some channels through which low aggregate demand could affect productivity, perhaps by lowering research-and-development spending or decreasing the pace of firm formation and innovation. I believe that the relationship between productivity growth and the strength of aggregate demand is an area where further research is required.

I will conclude by reiterating one aspect of the low interest rate and low productivity growth problems that I have mentioned previously–the fact that, for several years, the Fed has been close to being “the only game in town,” as Mohamed El-Erian described it in his recent book.5 But macroeconomic policy does not have to be confined to monetary policy. Certain fiscal policies, particularly those that increase productivity, can increase the potential of the economy and help confront some of our longer-term economic challenges. While there is disagreement about what the most effective policies would be, some combination of improved public infrastructure, better education, more encouragement for private investment, and more effective regulation all likely have a role to play in promoting faster growth of productivity and living standards. By raising equilibrium interest rates, such policies may also reduce the probability that the economy, and the Federal Reserve, will have to contend more than is necessary with the effective lower bound on interest rates.

Watch live: http://www.cfr.org/monetary-policy/conversation-stanley-fischer/p38477 Leaving the Board

Business Lending Crunched – Investment Lending Apart

The final set of ABS data on finance for July 2016 includes all forms of lending, and does not tell a good story. Whilst investment housing lending grew, lending for productive business growth fell, again.

Here is the summary, having separated business lending for housing investment purposes, versus the rest. As normal we will focus on the trend data, which irons out some of the noise in the data, to see through to the underlying movements.

Lending for secured construction and purchase of dwellings fell 0.1%, or $20m, month on month, secured alterations rose just a little, personal finance rose 0.1% or $6m and overall commercial lending fell 1.75% or $671m compared with last month, and continues to fall.

Within the business or commercial flows, lending for investment property rose 1.1% or $127m, compared with last month, whilst lending for other commercial purposes fell 2% or $384m. Revolving commercial credit fell 5% down $416m.

So productive lending to business continues to fall, and overall lending is being supported by more investment housing. As a result, the proportion of business lending for investment housing rose again to 31% of commercial lending, whilst lending for other commercial purposes fell again to 48.2% of all commercial lending. These trends need to be reversed if we are to get real productive economic growth to kick in.

abs-fin-jul-2016-allFinally, for completeness, here is the housing data, once again showing the ongoing rise in the proportion of investment housing lending, up 1.1% or $127m on last month, and up from 35.9% to 36.1% of total flows.

abs-fin-jul-2016-housingWe think tighter macroprudential measures are overdue.

NZ Tightens Mortgage Lending Rules From 1 October

The NZ Reserve Bank today confirmed that new macroprudential rules tighten restrictions on bank lending to residential property buyers throughout New Zealand. Residential property investors will generally need a 40 percent deposit for a mortgage loan, and owner-occupiers will generally need a 20 percent deposit.


From 1 October, residential property investors will generally need a 40 percent deposit for a mortgage loan, and owner-occupiers will generally need a 20 percent deposit. In both cases, banks are still allowed to make a small proportion of their lending to borrowers with smaller deposits.

Confirmation of the new rules is in the Reserve Bank’s response to submissions to its public consultation about changes to Loan to Value Ratio (LVR) rules that was issued on 19 July.

The Reserve Bank is modifying its proposals in response to public consultation, and also through meetings and workshops with banks that are subject to the rules.

The new rules take effect on 1 October 2016, but banks have chosen to start following the new limits already.

Existing exemptions to LVR restrictions will continue to apply under the new rules and have been extended to include borrowing for a newly-built home, or to do work needed for a residence to comply with new building codes and rental-property standards.


BIS, FSB and IMF publish elements of effective macroprudential policies

The International Monetary Fund (IMF), Financial Stability Board (FSB) and Bank for International Settlements (BIS) released today a new publication on Elements of effective macroprudential policies. The document, which responds to a G20 request, takes stock of the international experience since the financial crisis in developing and implementing macroprudential policies and will be presented to the G20 Leaders’ Summit in Hangzhou.


Following the global financial crisis, many countries have introduced frameworks and tools aimed at limiting systemic risks that could otherwise disrupt the provision of financial services and damage the real economy. Such risks may build-up over time or arise from close linkages and the distribution of risk within the financial system.

Experience with macroprudential policy is growing, complemented by an increasing body of empirical research on the effectiveness of macroprudential tools. However, since the experience does not yet span a full financial cycle, the evidence remains tentative. “The wide range of institutional arrangements and policies being adopted across countries suggest that there is no ‘one-size-fits-all’. Nonetheless, accumulated experience highlights – and this paper documents – a number of elements that have been found useful for macroprudential policy making,” the publication says. These include:

  • A clear mandate that forms the basis for assigning responsibility for taking macroprudential policy decisions.
  • Adequate institutional foundations for macroprudential policy frameworks. Many of the observed designs give the main mandate to an influential body with a broad view of the entire financial system.
  • Well-defined objectives and powers that can foster the ability and willingness to act.
  • Transparency and accountability mechanisms to establish legitimacy and create commitment to take action.
  • Measures to promote cooperation and information-sharing between domestic authorities.
  • A comprehensive framework for analysing and monitoring systemic risk as well as efforts to close information gaps.
  • A broad range of policy tools to address systemic risk over time and from across the financial system.
  • The ability to calibrate policy responses to risks, including by considering the costs and benefits, addressing any leakages, and evaluating responses. In financially integrated economies, this includes assessing potential cross-border effects.

The document includes some data on the use of macroprudential tools; illustrative examples of institutional models for macroprudential policymaking; and a brief summary of some of the empirical literature on the effectiveness of macroprudential tools.

“Usage” counts the number of countries using the various instruments that comprise each group. Assuming that once a country introduces an instrument, it continues using it, the charts show usage of the various groups of instruments.

MacroPruCountsInstitutional arrangements adopted by a country are shaped by country-specific circumstances, such as political and legal traditions, as well as prior choices on the regulatory architecture. While there can therefore be no “one size fits all” approach, in practice, there has been an increasing prevalence of models that assign the main macroprudential mandate to a well-identified authority, committee, or interagency body, generally with an important role of the central bank. While each of these models has pros and cons, any one model can be buttressed with additional safeguards and mechanisms.

  • Model 1: The main macroprudential mandate is assigned to the central bank, with its Board or Governor making macroprudential decisions (as in the Czech Republic, Ireland, New Zealand and Singapore). This model is the prevalent choice where the central bank already concentrates the relevant regulatory and supervisory powers. Where regulatory and supervisory authorities are established outside the central bank, the assignment of the mandate to the central bank can be complemented by coordination mechanisms, such as a committee chaired by the central bank (as in Estonia and Portugal), information sharing agreements, or explicit powers assigned to the central bank to make recommendations to other bodies (as in Norway and Switzerland).
  • Model 2: The main macroprudential mandate is assigned to a dedicated committee within the central bank structure (as in Malaysia and the UK). This setup creates dedicated objectives and decision-making structures for monetary and macroprudential policy where both policy functions are under the roof of the central bank, and can help counter the potential risks of dual mandates for the central bank (see further IMF 2013a). It also allows for separate regulatory and supervisory authorities and external experts to participate in the decision-making committee. This can foster an open discussion of trade-offs that brings to bear a range of perspectives and helps discipline the powers assigned to the central bank.
  • Model 3: The main macroprudential mandate is assigned to an interagency committee outside the central bank, in order to coordinate policy action and facilitate information sharing and discussion of system-wide risk, with the central bank participating on the committee (as in France, Germany, Mexico, and the US). This model can accommodate a stronger role of the Ministry of Finance (MoF). Participation of the MoF can be useful to create political legitimacy and enable decision makers to consider policy choices in other fields, e.g. when cooperation of the fiscal authority is needed to mitigate systemic risk.

Monetary versus macroprudential policies

Monetary policy, as currently being implemented, is failing to deal with the current raft of economic issues, including low inflation, stagnant wage growth, high asset prices and ultra low policy rates. When coupled with politicians taking a back seat and their inability to tackle the core issues, macroprudential measures are being tried, in a massive real-time experiment. This coupling of monetary and macroprudential action is largely untested. Can they work in tandem?

Bank-ConceptA Bank of England working paper “Monetary versus macroprudential policies causal impacts of interest rates and credit controls in the
era of the UK Radcliffe Report“, attempts to look at this issues, with some interesting results. They conclude that macroprudential policy is better suited to achieving financial stability goals than monetary policy.

The Global Financial Crisis and its disappointing aftermath are widely  viewed as a major macroeconomic policy disaster from which lessons must be learned. Yet agreement on the precise failures and, thus, the necessary lessons, has been elusive in many areas, from mortgage regulation to fiscal policy, and from global imbalances to central banking. In the latter case, the role of macroprudential policies remains fraught, with doubts about whether they should exist, if they work, and how they should be designed and used.

Reflecting this range of skepticism, several countries have recently taken quite varied courses of action in retooling their policy regimes since 2008. For example, facing a heating up of their housing markets in 2010–12, Sweden and Norway took quite different policy actions. Sweden’s Riksbank tried to battle this development using monetary policy tools only, raising the policy rate, and tipping the economy into deflation, as had been predicted by the dissident Deputy Governor Lars Svensson, who subsequently resigned. Across the border, the Norges Bank implemented some cyclical macroprudential policies to crimp credit expansion and moderate mortgage and house-price booms, without relying as much on rate rises, and they managed to avoid such an out-turn. Elsewhere, other countries display differing degrees of readiness or willingness to use time-varying macroprudential policies. The Bank of England now has both a Financial Policy Committee and a Monetary Policy Committee, and the former has already taken macroprudential policy actions under Governor Mark Carney. As Governor of the Bank of Israel, Stanley Fischer utilized macroprudential policies against perceived housing and credit boom risks, but now as Vice-Chair at the Federal Reserve his speeches lament the lack of similarly strong and unified macroprudential powers at the U.S. central bank. Yet as one surveys these and other tacks taken by national and international policymakers, two features of the post-crisis reaction stand out: the extent to which these policy choices have proved contentious even given their limited scope and span of operation, and the way that the debate on this policy revolution has remained largely disconnected from any empirical evidence. And of course, the two features may be linked.

This paper seeks a scientific approach that might address both of these shortcomings, by bringing a new and vastly larger array of formal empirical evidence to the table. To that end, we turn to the last great era of central bank experimentation with the same types of macroprudential instruments: the postwar decades from the 1950s to the early 1980s when many types of credit controls were put in play. We go back and construct by hand new quantitative indicators on the application of such policies in the UK, including credit ceilings, hire purchase regulations, special deposits, and the “Corset.” To evaluate the impacts of these policies, and to compare them with the impacts of the standard monetary policy tool of Bank Rate, we then implement a state-of-art econometric estimation of impulse-response functions (IRFs) to the two policy shocks by developing a new approach to identification that is also original to this paper, one that we shall refer to as Factor-Augmented Local Projection (FALP). Our approach unites the flexible and parsimonious local projection (LP) method of estimating IRFs with the Romer and Romer approach of using forecasts to mitigate the selection bias arising from policymakers acting on their expectations of future macroeconomic developments. To ensure greater robustness, we also borrow from the factor augmentation approach that has been employed in the VAR literature  as a means to control for other information correlated both with changes in policy and future macroeconomic developments. We subject our results to a range of robustness tests, most of which give us little reason to doubt our main results.

We report three main results. First, we find that monetary and credit policies had qualitatively distinct effects on headline macroeconomic indicators during this period. Increases in Bank Rate had robust negative effects on manufacturing output, and consumer prices especially, and positive effects on the trade balance. However, the estimated response of bank lending to an increase in Bank Rate is not statistically significant. By contrast, we find that credit controls — liquidity requirements on banks, credit growth limits, and constraints on the terms of consumer finance — had a strong negative impact on bank lending. We also find some evidence that credit policies may have depressed output, improved the trade balance, and led to an increase in consumer prices. But our evidence here is less strong than for corresponding shifts in Bank Rate. Overall, our estimates suggest that monetary and credit policies spanned different outcome spaces during this period. This result supports the notion that today’s macroprudential tools, which are close cousins of the credit policies studied in this paper, might provide the additional independent tools required to help central banks meet both their monetary and financial stability objectives.

Second, we find that our estimated monetary and credit policy shocks were major drivers of macroeconomic dynamics over the 1960s and 1970s. A significant fraction of lending and output dynamics can be explained by these shocks. Moreover, we find that a large fraction of the pick-up in inflation in the 1970s can be attributed to expansionary monetary policy shocks — that is, interest rates were substantially looser in the latter part of our sample than would have been expected given available econonomic forecasts and the information about the state of the economy contained in our estimated factors.

Third, our impulse responses indicate that credit policies had moderating effects on modern-day indicators of financial system vulnerabilities, while the effects of monetary policy actions were less clear cut. Contractionary credit policies had large and persistent negative effects on the credit-to-GDP ratio; they also reduced banks’ loan to deposit ratios (a measure of their resilience), and increased the spread between debentures i.e. term corporate debt instruments and gilts (a measure of investor risk appetite). In contrast, we find that contractionary monetary policy led to a persistent increase in the credit-to-GDP ratio, as the fall in GDP exceeded the fall in credit. Contractionary monetary policy actions also led to a small reduction in banks’ loan-to-deposit ratios, but led to a large persistent increase in the debenture spread. Our results therefore provide some support to the view that macroprudential policy is better suited to achieving financial stability goals than monetary policy.

Note: Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the Bank of England or to state Bank of England policy. This paper should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee or Prudential Regulation Authority Board