Rocky Times: New Perspectives on Financial Stability

6. Governance Issues for Macroprudential Policy in Advanced Economies

163 The recent severe financial crisis is leading policymakers around the world to adopt a new set of tools to manage their nation’s economy. Authori­ ties may be able to cushion the blow from dangerous financial crises by using a “macroprudential” approach that fits between monetary policy for the economy as a whole and traditional regulation of individual financial institutions (now referred to as “microprudential” regulation to distinguish it from the new ap­ proach). There are multiple definitions of “macroprudential,” but the core con­ cept is to manage factors that could endanger the financial system as a whole even if it would not be obvious that they were serious threats when viewed in the con­ text of any single institution. If risks such as excessive exposure to housing credit are common to many financial institutions simultaneously, they can, together with a high degree of interconnectedness between financial institutions, create Governance Issues for Macroprudential Policy in Advanced Economies 6 douglas j. elliott The author would like to gratefully acknowledge the support of the City of London Corporation and the helpful comments on previous drafts provided by a number of experts, including Martin Baily, Charles Goodhart, Don Kohn, Bob Litan, and several people who would prefer to remain anonymous. Any errors, of course, remain my own. I would also like to thank Natalie McGarry for her able research assistance. Finally, the views expressed are my own and do not necessarily represent those of the Brookings Institution or its staff or those of the City of London Corporation or its staff. 13118-06_CH06.indd 163 10/18/12 11:57 AM 164 douglas j. elliott systemic risks even though each individual institution appears sound, when the potential for financial contagion is ignored.1 This chapter examines one of the key issues in more detail: how should macro­ prudential authorities be structured and governed? Macroprudential policy has rarely been used in advanced economies in recent decades, and the structures to set policy in this area generally are very new or have not yet been formed. Even when an existing body is taking on macroprudential responsibilities, their nature will require new governance approaches. A number of questions therefore arise: —Should macroprudential policy be conducted by a single authority, mul­ tiple authorities, or a committee? —Which authority or authorities should be in charge of policy? —In practice, what entities will conduct macroprudential policy in the major financial centers? —What objectives should the macroprudential authority pursue? —What tools should be available to the macroprudential authority? —How should macroprudential authorities decide whether, when, and how to take action? —To what extent should authorities use subjective judgment? —How should macroprudential policy be coordinated with monetary policy? —How should macroprudential and microprudential policy be coordinated? —How should policy be coordinated internationally? —How would authorities deal with regulatory arbitrage? —How can proper accountability for macroprudential decisions be ensured? —What other structural issues are important for sound governance? —What is the optimal strategy for communicating macroprudential actions and their effects? —How can the authorities counteract political pressure not to puncture bubbles? —What are the major risks facing the macroprudential authorities? Should Macroprudential Policy Be Conducted by a Single Authority, Multiple Authorities, or a Committee? As with monetary policy, high-level macroprudential policymaking needs to be decided by a single body. A country would not set up multiple central banks with authority over different parts of its financial system, and it would be awkward— 1. Those unfamiliar with macroprudential policy may wish to read the author’s comprehensive primer on the topic, written for nonspecialists (see www.brookings.edu/papers/2011/0311_capital_elliott.aspx). Parts of this chapter draw directly from that primer, although most of the chapter consists of new material. 13118-06_CH06.indd 164 10/18/12 11:57 AM governance issues for macroprudential policy 165 and potentially disastrous—to have multiple authorities making separate deci­ sions about the state of the credit cycle and the need for macroprudential inter­ vention. However, there is room for the authority to be vested either in a single body or in a committee that makes a coordinated overall decision, and different countries have chosen different paths in this regard. Execution of any decisions could also fall onto different bodies, depending on the tool or tools chosen for use by the macroprudential authority. A number of the pros and cons of setting up a single macroprudential author­ ity rather than a committee follow...