It has always been clear that the aim should be to increase the resilience of the system to adverse shocks, but is it possible to be more ambitious? The traditional prudential approach has had a strong focus on shock-absorbing capacity; for example, increasing capital requirements so that banks are better able to absorb loan losses. This approach largely takes movements in credit and asset price cycles as a given, and aims to provide an adequate safety net should systemic risks be realised. A more ambitious approach is to try to reduce the amplitude of the financial cycle – in a sense lopping off the extremes of the cycle. Swing low but not too low; swing high but not too high. The potential benefits of this approach are obvious but it is also much more demanding, as it requires the authorities to answer some difficult questions.
Hmmm. This seems to be saying that simply ensuring the resilience of the financial system is not enough, the central bank should be trying to exert direct, and discretionary, control over what financial markets do and where investment heads. Fine tuning at its finest. It does appear that policymakers here have been strongly influenced by Borio.
That’s me, I’m done with writing about macroprudential policy in New Zealand. If you want to know why, read below the flap 😉
The Bank is moving away from its mandate with actions like this. They say that additional action beyond ensuring shock absorbing capacity in financial markets makes sense as:
a disorderly unwinding of a credit boom to impose substantial losses on the financial system, leading to an adverse feedback cycle with the real economy and substantial damage in the form of lost economic output, jobs and wealth
But the entire point there is “disorderly”. If prudential policies are focused on ensuring that the banking system has a sufficient buffer against adverse shocks, the wind down of a credit boom is not “disorderly”. This entire story is a red herring.
Standing against deteriorating lending standards, ensuring banks are holding sufficient equity/capital, that is accepted widely and I’m on board. But that doesn’t mean we should be chasing around asset prices driven by a ‘credit monster’. If there is a “bubble” when lending standards are unchanged and financial markets are not at risk, there is NO ROLE for central banks. Central banks are not there to pick who the winners and losers of transfers are. Central banks are not there to determine investment decisions for individuals firms and industries. That is a central planner – the two are spelled differently.
I suppose this change in tack from the Bank makes “sense” if we think about some of the recent talk. For some strange reason the Bank has suggested that LVR (loan-to-value mortgage) limits could be in place for years – even though real estate agents and second-tier lenders are trying to undercut the regulations before they have even begun. If the Bank’s goal is to create a unregulated shadow banking system, then sure keep LVR limits in place for years. They have also seemed incredibly willing to use transfer and equity/fairness arguments when it is not their role (here and here).
The level of discretion they are suggesting staggers me. Here:
We do not see macro-prudential instruments as ‘set and forget’ tools; once deployed, there will be on-going assessments of their effectiveness, which will condition their use and their eventual release
There is a positive way to read this – namely that they are building capabilities and an understanding of the efficacy of the tools. That is positive. But in conjunction with their objective, this sounds like macroprudential tools based on discretion rather than rules – violating the points raised by Cochrane.
And what exactly does the Bank think this means for their future independence? They seem to be including the price of assets, including housing into their mandate. Furthermore, they are taking responsibility on investment going to the “right” places … eg:
instruments such as the SCR or LVR restrictions could be targeted at particular problem sectors, such as housing or agriculture, or specific borrower segments such as housing investors
If that is the way they want to communicate their new tools and their innovative thinking to the public, then I think it is fairly obvious we should start having open democratic elections for the RBNZ governor – that or just wrap it straight back into central government.
No doubt many think I’m being over the top here, but when thinking about the justification for macro-prudential policy I had firm limits on how this would fit within the mandate of an independent central bank. And the RBNZ feels justified to go beyond that. This is me just putting on record that they’ve overstepped what seems appropriate 😉
Note: When I read papers like that, I see a central bank wanting to “solve every problem” and even seeing it as their purpose. It is not. They are there to deal with issues which the government cannot commit itself to – namely monetary policy. They are also supposed to be financial market regulator, which involves dealing with stability of the financial system.
However, they believe they have found a new task – helping us help ourselves, credit constraining us when we get too excited and easing that constraint when we are scared. I do not have the faith in their knowledge of social value, nor do I think they can successfully keep credibility about monetary policy while following such a discretionary path with monetary policy consequences with other tools. To quote Bernanke again:
In the United States, the heyday of discretionary monetary policy can be dated as beginning in the early 1960s, a period of what now appears to have been substantial over-optimism about the ability of policymakers to “fine-tune” the economy. Contrary to the expectation of that era’s economists and policymakers, however, the subsequent two decades were characterized not by an efficiently managed, smoothly running economic machine but by high and variable inflation and an unstable real economy, culminating in the deep 1981-82 recession.
To the Bank I have one question – what is your implied welfare function that involves you trying to second guess individuals choice of where to invest and what in? Is it based on a presumption that you simply know what is good for people better than they do, has their been some actual consideration in terms of normative economics. I bring this up primarily because, if you are going to get involved in the game of justifying direct policy interventions like a central government you need to be able to justify them in the same ways, with the same sort of CBA measurements, and with the same level of certainty.
Side note: Since I genuinely don’t plan to post about macroprudential policy again outside of “interest links posts”, I have to note I also agree with Lars Christensen in this link:
So I remain skeptical about the usefulness of macroprudential policies – in fact I believe that an over-reliance on such policies could lead to an increase in the volatility and fragility of the global financial system rather than the opposite.
When the policies become discretionary, and the Bank focuses on micromanagement, the actual goal of stability can be compromised.