The effectiveness of
macroprudential tools
Gabriele Galati (De Nederlandsche Bank)
Banco de Portugal Conference on “Financial Stability and
Macro-Prudential Policy”, 10 February 2015
1
Disclaimer: The views expressed are those of the author and should
not be taken to reflect those of DNB or of the Eurosystem.
2
“We are all macroprudentialists now”

Growing consensus that a macroprudential
approach to regulation and supervision
should be adopted. Policymakers around the
globe are implementing macroprudential
policy tools and frameworks.
3


Macro-prudential policy […] has the objective
of safeguarding financial stability, by
strengthening the resilience of the financial
sector and preventing systemic risk.
The effectiveness […] will be assessed by
monitoring a set of indicators that signal risk
factors and by measuring progress against the
intermediate objectives. This assessment will
enable […] to assess the adequacy of its
intermediate objectives and instruments.
(Banco de Portugal Press Release, 29 December 2014.)
4
But what do we know about how
macroprudential tools work?
From a theoretical point of view, no agreed
modeling framework of the interaction
financial system - macroeconomy.
 Empirical evidence on effects of
macroprudential tools still scarce, since they
are introduced widely only in recent years.
Policy ahead of research
 However, major research efforts over the
past few years to fill the gap

5
Compare this to monetary policy…
Rich literature and standard workhorse for
modelling optimal monetary policy and the
monetary transmission mechanism
 Large body of empirical evidence on
transmission channels and effectiveness
 But since the crisis, less certain about how
monetary policy, particularly non-standard,
works
 Both literature strands are at the same
crossroads

6
Four approaches to study
effectiveness and transmission

Analysis of historical experiences


Stylized presentations


e.g. transmission maps (CGFS, 2012)
Theoretical approaches


e.g. Haldane, 2011; Elliott, 2013
Banking models, DSGE macro
Empirical analysis

Alternative identification strategies
7
What have we learned?
(I) Advances in methodology


Banking models: introduce meaningful role of
time and the business cycle to study
macroprudential tools that address the
procyclicality of the financial system.
Use general equilibrium analysis to analyze
risk-taking behavior of heterogeneous agents
in an economy that is vulnerable to systemic
risk and in which default can occur
8



Macro models: beyond linearization,
complete markets and no/exogenous default
DSGE models with financial-real linkages can
explain how these can generate systemic
crises - rare events resulting from “credit
booms gone wrong” followed by deep and
long recessions (Boissay et al., 2013).
Infinite-horizon DSGE models with
occasionally binding endogenous constraints
improve understanding of role of regulation in
reducing the incidence of financial crises (e.g.
Bianchi and Mendoza, 2010).
9


Empirical methods: different strategies to
identify impact on macroeconomic and
financial variables, i.e. how to distinguish
correlation and causation.
Event studies; assessments of authorities/
outside observers; reduced-form regression
analysis (cross-country panel regressions);
macro stress tests; counterfactual analysis;
analysis based on micro data.
10
(II) Insights




Macroprudential policy can help reach
intermediate targets (credit growth,
mortgages) but impact on financial stability
hard to quantify.
General equilibrium effects important.
Pigouvian taxes can address externalities
that underpin endogenous systemic risk.
State-contingent taxes linked to leverage can
play an important role for financial stability by
supporting precautionary savings.
11
New regulation will induce banks, savers to
endogenously alter their other portfolio
choices.
“Disturbing interactions” between tools




E.g. countercyclical bank regulation might
increase cross-sectional risk, while policies that
reduce cross-sectional risk reduce procyclicality
(Horvath and Wagner, 2013).
Leakages – cross-border, between types of
financial institutions – can be important.
Lack of coordination macroprudential monetary policy can reduce effectiveness.
12
Challenges


Tricky to identify effect of macroprudential
measures typically not taken in isolation but
in combination with other policies.
The transmission mechanism is likely to
change over time as the result of changes in
financial intermediation practices and in the
structure of the financial system

financial innovation, consolidation in the financial
sector and changes in the balance between
institution- and market-based credit affect
systemic risk over time.
13

The interaction with monetary policy affects
the transmission mechanism.



Think of non-standard measures aimed at
supporting credit supply when banks are facing
pressure to raise capital buffers.
Governance aspects are important but are
hard to model.
Need to capture interaction of regulation of
different types of financial institutions

Think of Basel 3 – Solvency 2
14
Thank you.
15
Additional slides
16
Two waves of historical experiences
(1) Restrictions on asset and liability side of
banks’ balance sheets in the 1930s and
following decades in an effort to support the
domestic banking system (Haldane, 2011).
 Literature suggests many of these tools may
have succeeded in their short-term goals


Helped limit (specific types of) bank credit
… but less obvious that they improved
financial stability (e.g. Elliott, 2013).
17
(2) In more recent years, macroprudential tools
adopted – mostly in EMEs – to strengthen the
resilience of the domestic financial system.
 Typically two types of measures


limit credit supply to specific sectors prone to
excessive credit growth (e.g. caps on LTV ratios
or debt/income ratios to limit mortgage lending)
prevent build-up of imbalances from cross-border
capital flows (e.g. via reserve requirements).
18