Q&A: Seven Questions on Macroprudential Policy Frameworks

• Author: Itai Agur and Sunil Sharma
• Pages: 5-7

5

September 2013

Implementing macro-

prudential policy and

dealing with the politi-

cal economy is likely

to be hard. But limit-

ing policy discreti on

through the formulation

of macroprudential rules is complicated by the difficulties

in detecting and measuring systemic risk. This Q&A article

provides brief answers to seven questions about macropru-

dential policy in light of recent research by Itai Agur and

Sunil Sharma (2013). Their findings suggest that oversight is

best served by having a strong baseline regulatory regime on

which a time-varying macroprudential policy can be added

as conditions warrant and permit.

Question 1: What is the justification for requiring a

greater macroprudential orientation for economic and

financial policies?

ree types of ex ternalities that can lead to sys temic

fragilit ies justify the need for macroprudential pol icies (De

Nicolò, Favara, and Ratnovski, 2 012): (i) interconnectedness

of markets and intermedia ries that can propagate shocks

through the na ncial system; (ii) strategic complementari-

ties that generate correlated risk s among nancial institu-

tions and markets; and (iii) re sa les of nancial assets that

can lead to a cycle of declin ing asset prices and weakened

balance sheets of na ncial intermediaries.

e objective of macroprudential polic y is to limit sys-

temic risk by nding ways to da mpen the eects of business

and nancial c ycles, to handle interconnectedness and the

buildup of common exposures by inst itutions and market

players, and to catch credit and asse t bubbles in their infancy

rather than havi ng to deal with them when they are consid-

erably distended and punct uring asset bubbles may lead to

much economic and nancial mayhem.

Question 2: What are the challenges inherent in

measuring systemic risk?

By their very nature, s ystemic threats are “tail events,”

they represent an agglomeration of ri sks from a variety of

channels, and colle cting data and views to make ass essments

is dicult since i n most situations it is likely to involve a

multiplicity of sources and agencies . While systemic risk

measurement has made some progress in recent years

prodded on by the nancial cr isis, it has not yet produced

a satisfactory measu re, despite the variety and complexity

of models and methods used (Bisias a nd others, 2012). e

measurement of systemic risk thus conti nues to proceed

without a comprehensive operational denition.

Systemic risk in the f uture may also arise in very di erent

ways and it may not be captured by our exist ing intelligence

systems. Moreover, one lesson from this crisis t hat surely

carries over to futu re crises is the non-linearity of eects i n a

complex evolving economy (Haldane, 2012). Suddenly, some

very fuzzy bou ndaries are crossed and the system spir als

away from an ostensibly stable equilibr ium, into the abyss.

reshold eects severely complicate eort s to quantify the

risk of a systemic crisis , and make it particularly d icult for

a warning system to b e “early,” and not just begin to ash

red when it is too late to contain the risk s or the fallout from

their rea lization.

Question 3: How do the nature of systemic risk and the

difficulties associated with measuring it influence the

conduct of macroprudential policy?

Consider how policymakers wou ld use an early warn-

ing system. ey have two options: either t hey specify in

advance what measures w ill be taken when systemic risk is

apparent, or they wait unti l the warning signals are a sh-

ing red and then decide on a set of act ions. e latter option

leaves full dis cretion in the hands of the regulators, and

depending on institut ional and political structu res such dis-

cretion could open the door to resista nce from the nancial

industry, politicians , and even the public.

e challenges associ ated with systemic risk measurement

make it dicult to operat ionalize the rst option: a time-

varyi ng policy that is rules based. e key to a succ essful rule

is the ability to spec ify in advance the policy ac tion that will

be taken when a certa in event happens, and having the cred-

ibility to implement the policy when t he need arises. In the

context of macroprudential regu lation, the “event” is the rise

of systemic risk beyond some threshold a nd the “action” is the

Seven Questions on Macroprudential Policy Frameworks

Itai Agur and Sunil Sharma

Q&A

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