Yar, definitely agree with you.

Its been a useful conversation – this is the sort of reason I like blogging, it is useful to flesh these things out and to get useful information out of other people 😉

For the record, I’m ambivalent about separation. But you’re arguing the ‘pro’ and I’m probably the only person here who cares to argue the ‘con’…

Interesting. You are right that the distinction should be between structural and cyclical – not arbitrarily between micro and macro. When I was thinking macro I was thinking along the lines of reserve ratios changing over the cycle – when I was thinking micro I was thinking specifically of the basel capital rules.

In both cases there is a focus on financial stability – and from separate reasons and channels. And I can buy the fact that these rules – both cyclical and structural – are so interlinked with the idea of financial stability that they should all be controlled by one organisation.

However, I still think that this organisation should be separate from the monetary authority – whose goal is essentially price stability, and the smoothing of the economic cycle that is part of that aim.

This way we have two given outcomes, and two distinct authorities that can take responsibility for said action. Their choices impact upon the choice of the other organisation – no doubt – but the separation increases transparency and allows them to help control expectations.

I don’t agree with that distinction. Macro- and micro-prudential regulation are meant to be complementary – in fact, the basis for macro-prudence is the belief that stabilising the parts of the system is not sufficient for the stability of the whole. They have the same goal, namely reducing the tail risk of a costly collapse (with some nod towards efficiency if you like, to keep them from going power-mad). That gives both of them the scope for cyclical or structural measures. Some examples:

Basel capital accord = micro, structural
Core funding ratio = micro, cyclical
Local incorporation rules = macro, structural
Mortgage levy = macro, cyclical

You might quibble with my categorisation, but I’m sure you see the point.

“Errr… I think to take this any further I’d need to know what you have in mind in the way of structural vs cyclical regulations.”

Fair call. Sorry I’ve been awful in this post – I had ideas for about 4-5 posts, realised I didn’t have time, tried to write all the things I wanted indirectly in one post, and ended up with a pile of gunk 😉

When I say cyclical vs structural one potential set of policies I would have in mind is the difference between macro-prudential regulation and micro-prudential regulation.

“You’ll also need to explain to me why it would require more regulators rather than just more instruments.”

I don’t envisage more regulators persee – just the “operational separation” of the elements. The same way telecom got operationally separated.

Like I say, its to make the message clear and to make a set group seem “responsible” because there is only one thing placed on them.

“The incentives faced by the regulators mean that “cyclical” measures will have a nasty habit of becoming permanent, and that “structural” measures will be dictated by the cycle as regulators try to fight the last battle”

This is true – but for some reason I think clear separation makes this occurance less likely, while the status quo is likely to lead to policy from central banks becoming incoherent.

“I agree with you that there are definite public policy issues here – but my prior belief is always that we should start with a clear transparent distinction for policy, and that any public policy issues are second order.”

I can understand that as a general rule, but for what you’re specifically proposing I think the public policy issues are unavoidable. The incentives faced by the regulators mean that “cyclical” measures will have a nasty habit of becoming permanent, and that “structural” measures will be dictated by the cycle as regulators try to fight the last battle. The distinction can’t be maintained.

“But then does the central bank get a say in whether or not it hands over billions of dollars to another government department?”

No.

“But as I said, financial regulators are rarely criticised in normal times – bank-bashing is politically popular and the costs of inefficient regulation are unseen. ”

Hmmm, I’m not sure how much concern I have for the way people view banks in this context – the key point is that the role of any structural regulation separate from cyclical regulation and separate again from monetary policy.

I agree with you that there are definite public policy issues here – but my prior belief is always that we should start with a clear transparent distinction for policy, and that any public policy issues are second order. I can be swayed on this, but as with all beliefs I’d probably have to see something.

“The RBNZ’s woolly financial stability mandate is a product of how (and when) its legislation was written; the mandate could easily be tightened up without resorting to separation.”

I agree that in the absence of separation this is also an improvement – clearly defined mandates are really the key point in all of this. One organisation with a clear mandate would be superior than a separation that is unclear and confused.

“Yeah, “blame” is the idea I was grasping at. I can’t imagine a central bank ever being able to blame its inability to contain inflation on the need to clamp down on banks, since the ‘right’ policies in each case would actually be complementary”

If the impact of policy was solely cyclical then there is a justification for this. However, in the case of a structural impact of policy – if the set of loans being made by banks are being redirected by policy in some way – then there should be a separate body that is responsible for this, so that any misallocations resulting from it can be clearly pinned down.

But then does the central bank get a say in whether or not it hands over billions of dollars to another government department? This sounds like adding another layer of bureaucracy to no real benefit.

“I would note that having a separate authority that has a single, testable, role is more likely to be criticised clearly than one that has multiple roles.”

But as I said, financial regulators are rarely criticised in normal times – bank-bashing is politically popular and the costs of inefficient regulation are unseen. Generally the only ones who push back against bad regulation are the ones being regulated – that happens whether or not the regulator is a separate authority. Granted, the banks might be better placed to win a PR war against a combined authority, by running the line that “so-and-so policy will push up mortgage rates”; but that would point towards under- rather than over-regulation.

“The central bank is inherently less democratic than government, or fiscal authorities”

Ditto for financial regulators, that’s why both should be given clear mandates. The RBNZ’s woolly financial stability mandate is a product of how (and when) its legislation was written; the mandate could easily be tightened up without resorting to separation.

“My example of one “serving” the other would solely be on the basis of attributing blame”

Yeah, “blame” is the idea I was grasping at. I can’t imagine a central bank ever being able to blame its inability to contain inflation on the need to clamp down on banks, since the ‘right’ policies in each case would actually be complementary (e.g. the latest research – which I think you linked to a while back – finds that keeping interest rates too low for too long leads to looser lending standards).

“You’re right there’s a cost if the regulator pushes too far, but I don’t think it’s right to just say “there is a cost”. ”

Fair point. When I said their was a cost, I was comparing it to an optimal allocation. Now, of course if the bank faces the incentive to lend too much in general then they aren’t pushing for the optimal allocation – I agree.

However, I was meaning my statement to be in comparison to the “optimal allocation” where moral hazard is not an issue. Why did I do this strange thing? Because I wanted to describe the acceptance of a “allocative efficiency loss” as a second-best outcome relative to one where we just let the moral hazard issue run around.

So the realistic outcomes aren’t as good – but by comparing them to the “first best” outcome, we can say which one is relatively closer, and which one we should do. I was concerned because we are willing to say that we get a benefit by setting up these RR conditions – but it is only when we compare both outcomes to the first best outcome that we get an idea of this allocative efficiency loss. I’m sorry that I was so unclear – I’ve obviously had too much coffee today 😉

“A more practical solution would be to make it explicit that the RBNZ has the OCR and other measures focused on stability and regulations focused (in part or whole) on dealing with moral hazard. Do you think that would be enough?”

When it comes to actually setting policy, I can legitimately understand why a bunch of tools would be used – I would like the case to be made clearly before it happens, but I can understand why.

My main concern is I think there needs to be operational separation between the different tools – as you can tell from the comments so far this isn’t necessarily an agreed upon thing, it is just a belief of mine.