Macroprudential policy – closing the financial stability gap

Author:Stephan Fahr, John Fell
Position:DG-Macroprudential Policy and Financial Stability, European Central Bank, Frankfurt am Main, Germany

Purpose The global financial crisis demonstrated that monetary policy alone cannot ensure both price and financial stability. According to the Tinbergen (1952) rule, there was a gap in the policymakers’ toolkit for safeguarding financial stability, as the number of available policy instruments was insufficient relative to the number of policy objectives. That gap is now being closed through the creation of new macroprudential policy... (see full summary)

Macroprudential policy closing
the nancial stability gap
Stephan Fahr and John Fell
DG-Macroprudential Policy and Financial Stability, European Central Bank,
Frankfurt am Main, Germany
Purpose The global nancial crisis demonstrated that monetary policy alone cannot ensure bothprice
and nancialstability. According to the Tinbergen (1952) rule, there was a gap in the policymakerstoolkitfor
safeguardingnancial stability, as the number of available policy instruments was insufcientrelative to the
number of policyobjectives. That gap is now being closed through the creationof new macroprudential policy
instruments. Both monetarypolicy and macroprudential policy have the capacity to inuence both priceand
nancial stability objectives. This paper develops a framework for determining how best to assign
instrumentsto objectives.
Design/methodology/approach Using a simplied New-Keynesianmodel, the authors examine two
sets of policy trade-offs,the rst concerning the relative effectivenessof monetary and macroprudential policy
instrumentsin achieving price and nancial stability objectives andthe second concerning trade-offs between
macroprudentialpolicy instruments themselves.
Findings This model shows that regardless of whether the objective is to enhance nancial system
resilienceor to moderate the nancialcycle, macroprudential policies aremore effective than monetary policy.
Likewise, monetary policy is more effective than macroprudential policy in achieving price stability.
According to the Mundell(1962) principle of effective market classication,this implies that macroprudential
policy instruments should be paired with nancial stability objectives, and monetary policy instruments
should be paired with theprice stability objective. The authors also nd a trade-offbetween the two sets of
macroprudentialpolicy instruments, which indicates that failureto moderatethe nancial cycle would require
greater nancialsystem resilience.
Originality/value The main contribution of the paper is to establish with the help of a model
framework the relative effectiveness of monetary and macroprudential policies in achieving price and
nancial stabilityobjectives. By so doing, it provides a rationalefor macroprudential policy and it shows how
macroprudentialpolicy can unburden monetary policyin leaning against the wind of nancial imbalances.
Keywords Financial stability, Monetary policy, Systemic risk, Macroprudential policy,
Policy assignment, Tinbergen rule
Paper type Research paper
1. Monetary policy and macroprudential policy: two distinct policy domains
for the macroeconomy
1.1 The nancial crisis has shown monetary policy to be insucient to ensure nancial
An important policy lesson of the global nancial crisis that erupted in 2008 was that the
attainment of price stability is insufcient for ensuring nancial stability. The inordinately
large costs of the crisis challenged the Jackson Hole consensus, the prevailing orthodoxy
The views and opinions expressed in this article are those of the authors and do not necessarily
reect those of the European Central Bank or its Governing Council. The authors would like to thank
Pablo Aguilar, Richard Barwell, Markus Behn, Frank Smets, Matija Lozej, Dirk Schoenmaker and
Frank Smets for fruitful discussions and comments.
Journalof Financial Regulation
Vol.25 No. 4, 2017
pp. 334-359
© Emerald Publishing Limited
DOI 10.1108/JFRC-03-2017-0037
The current issue and full text archive of this journal is available on Emerald Insight at:
which held that central bankersmaintaskistokeepination low and stable and that
monetary policy should not attempt to counteract asset price booms (Bean et al.,2010;
Issing, 2011;Mishkin, 2010;White, 2009). In so doing, it reopened the so-called leaning
versus cleaningdebate,that is, the question of whether it is less costlyfor a central bank to
take measures which prevent nancial crises or, instead, to respond by cleaning up after a
crisis has materialised,with the Jackson Hole consensus favouring the latter approach.
As Borio (2012) explains, one of the analytical implications of the global nancial crisis
was a rediscovery of the notion of nancial cycleswhich had been prominent in the writings
of Kindleberger (1978)and Minsky (1977). While there is no commonly accepted denitionof
what constitutes a nancial cycle, it is generally taken to mean the endogenous cycles in
perceptions of nancial risk that begin with episodes of nancial exuberance, leading to
nancial imbalances and,eventually, to a so-called Minsky moment where there is a sudden
and major collapse of asset values that leads to a nancial crisis[1]. With its rediscovery, a
new objective for policymakers of taming the nancial cycle emerged (Barwell, 2013). The
challenge for policymakers has been to identify the instruments that are best suited to this
task. There are several reasons why great caution should be exercised in using monetary
policy instruments to moderate the nancial cycle, two of which have been made clear by
the crisis.
First, nancial cycles are distinctfrom, longer in duration and greater in amplitude than
business cycles (Borio and Drehmann,2009;Claessens et al.,2011,2014;Schüler et al.,2015).
These different cyclical features create potential for desynchronisation between business
and nancial cycles so thatmonetary policy instruments will be insufcient to achieveprice
and nancial stability objectivesat all times. Figure 1 illustrates this for a stylised situation
Figure 1.
Stylised businessand
nancial cycles
Closing the
stability gap

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