The Grand Unifying Theory (and Practice) of Macroprudential Policy Mark Carney Governor, Bank of England 5 March 2020
Newtonian Mechanics… and Madness 2
Triumph (and Tragedy) of Monetary Policy Time inconsistency: resolved by society choosing preferred rate of inflation, then delegating operational responsibility to the monetary authority. MPC’s monetary policy remit: achieve price stability, defined by the Government as 12-month CPI inflation of 2%. Target is symmetric and applies at all times. Temporary deviations from target: recognised explicitly in remit since 2013; Bringing inflation back too rapidly could cause undesirable volatility in output and employment. 3
Triumph (and Tragedy) of Monetary Policy Monetary policymaker’s loss function 4
Central banks won the war only to lose the peace Total UK private non-financial sector credit growth UK Inflation per cent per cent of 9 GDP 180 8 160 7 6 140 5 120 4 3 100 2 80 1 60 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 -1 5
Financial crisis powerful reminder of imperative of financial stability 2000 2008 2019 UK real wages have only $15 trillion to backstop the Trust in the system just surpassed their 2007 system in 2008 collapsed level 6
Advent of Macroprudential Policy Raison d’être is to ensure the financial system supports the economy by Lending to Ensuring downturns not households and made worse by businesses when unsustainable debt economic shocks burdens occur 7
Advent of Macroprudential Policy Increasing use of macroprudential measures over time And speeches mentioning “ macroprudential ” Number of speeches 250 14 AEs EMEs 12 200 10 150 8 6 100 4 50 2 0 0 19982000 02 04 06 08 10 12 14 16 1995-2000 2001-06 2007-12 2013-18 Sources: Bank of International Settlements Sources: Bank of International Settlements 8
When it comes to financial stability, success is an orphan Proportion of countries with banking crises Per cent of countries 50 The Great Depression Global Financial 40 Crisis Systemic crises in emerging markets, Nordic countries, Japan, 30 and the US (Savings and Loans) World War I The Panic of 20 1907 10 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 9
Grand Unifying Theory of Macroprudential Policy To identify, monitor and take action to remove or reduce systemic risks with a Primary view to protecting and enhancing the resilience of the UK’s financial system objective Secondary Support the economic policy of Her Majesty’s Government, objective including its objectives for growth and employment. Not required or authorised to exercise functions in a way that would in its opinion be likely to have a significant adverse effect on the capacity of the financial sector to And… contribute to the growth of the UK economy in the medium or long term. 10
Grand Unifying Theory of Macroprudential Policy Macroprudential policymaker’s loss function 11
Monetary Policy vs Macroprudential Policy Clarity of objectives: MPC’s primary objective readily measured; FPC’s primary objective only estimated Impact on growth: MPC limited ability to influence trend growth. FPC policies potentially important for trend growth given permanent scarring from crises and influence on productive finance Time horizon: Longer horizon means discount rate more important for FPC 12
Monetary Policy vs Macroprudential Policy Monetary policymaker’s loss function Macroprudential policymaker’s loss function 13
Intermediate indicators suggest UK risks around standard Macro environment Real house prices HH credit PNFC credit Expected change in level of GDP, three years ahead 6 Current account Volatility Capital ratios GDP-at-risk 4 Tail risks reducing 2 0 -2 -4 Tail risks increasing -6 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 Sources: BIS, OECD, Datastream, ONS, Bank calculations. 14
Risks surged during the Great Moderation, now standard GDP-at-risk low 0.15 Prob. Density 0.10 Risks increased until 2008 0.05 20 15 0.0 10 1998 2002 2006 2010 2014 2018 5 Real GDP Growth 0 -5 -10 Risks crystallised in the crisis 15
Risks surged during the Great Moderation, now standard Probability density 0.14 Latest 0.12 0.10 1997 0.08 0.06 2007 0.04 0.02 0.00 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 Cumulative GDP growth over 3 years (%) 16
Monetary Policy vs Macroprudential Policy Monetary policymaker’s loss function Macroprudential policymaker’s loss function 17
Reducing GDP-at-risk more valuable at higher levels of GDP-at-risk Social cost of financial instability: F (GDP-at-risk) A B A C Tail risks increasing (GDP-at-risk worsening) as move further right
Divine Coincidence generally held in US, Euro area but rarely for UK post-crisis EA US UK 6 6 Inflation (%) Inflation (%) Inflation (%) Inflation (%) 4.5 4.5 4 4 Inflation (%) Inflation (%) 5 5 3.5 3.5 4 4 4 4 3 3 3 3 2.5 2.5 2 2 2 2 2 2 -5 -5 -4 -4 -3 -3 -2 -2 -1 -1 0 0 1 1 2 2 -8 -8 -6 -6 -4 -4 -2 -2 0 0 2 2 4 4 -4.00 -4.00 -3.00 -3.00 -2.00 -2.00 -1.00 -1.00 0.00 0.00 1.00 1.00 2.00 2.00 3.00 3.00 4.00 4.00 1.5 1.5 1 1 Output gap (%) Output gap (%) Output gap (%) Output gap (%) 1 1 0 0 0 0 0.5 0.5 -1 -1 Output gap (%) Output gap (%) 0 0 -2 -2 -0.5 -0.5 -2 -2 -3 -3 -1 -1 -4 -4 Pre-financial crisis Financial crisis and after -5 -5 Sources: Bureau of Economic Analysis, CBO, Eurostat, IMF and Bank calculations. 19
FPC’s housing tools reduce GDP -at-risk Housing tools reduce GDP-at-risk whilst minimising negative impact on central GDP forecast. Example of targeted, efficient policy tool. 20
FPC housing tools reduce GDP-at-risk Changes in consumption relative to income among Per cent of households with stressed debt-servicing mortgagors with different LTI ratios (2007-2009) ratios above 40% Per cent of households 2018 End of scenario (with policy) Stressed DSR = 40% End of scenario (no policy) Sources: Living Costs and Food (LCF) Survey, ONS and Bank calculations 0 25 50 75 100 Stressed DSR, per cent 21
FPC tools have positive net benefits Costs and benefits of the housing tools under different scenarios Per cent of GDP 3 Benefits Costs Net Impact 2 1 0 -1 Central Upside Boom Sources: FCA Product Sales Database, ONS, Bank calculations. 22
FPC housing tools more efficient than monetary policy to address risks from household debt 1yr ahead median GDP growth 1yr ahead median GDP growth 1yr ahead median GDP growth 4.0 4.0 4.0 forecast (%) forecast (%) forecast (%) 2014 3.5 3.5 3.5 2004 If FPC housing tools 2004 had been in place 2007 3.0 3.0 3.0 2000 If monetary policy acted to achieve 2015 same reduction in GDP-at-risk 2006 2.5 2.5 2.5 1998 2005 2001 2003 2.0 2.0 2.0 2017 2016 2010 2013 2002 1.5 1.5 1.5 2018 2011 2008 1999 2019 1.0 1.0 1.0 0.5 0.5 0.5 2012 3yr ahead 5 th percentile GDP growth estimate 3yr ahead 5 th percentile GDP growth estimate 3yr ahead 5 th percentile GDP growth estimate (%, cumulative) (%, cumulative) (%, cumulative) 0.0 0.0 0.0 -6.0 -6.0 -6.0 -5.0 -5.0 -5.0 -4.0 -4.0 -4.0 -3.0 -3.0 -3.0 -2.0 -2.0 -2.0 -1.0 -1.0 -1.0 0.0 0.0 0.0 1.0 1.0 1.0 2.0 2.0 2.0 Sources: BIS, OECD, ONS and Bank calculations. 23
Optimal bank capital ratios balance impact on GDP-at-risk and trend growth Bank capital requirements balance reducing GDP-at-risk vs dampening investment and productivity. CCyB cushions shocks in a downturn, and matches resilience to risk environment. 24
Optimal bank capital ratios balance impact on GDP-at-risk and trend growth Conceptual illustration of how the FPC calibrated the Estimated net cost of higher capital requirements optimal capital ratio Annual GDP cost of moving away from the Estimated cost/benefit of capital appropriate capital ratio (in % of GDP) 0.02 11% optimum 0 -0.02 -0.04 -0.06 -0.08 -0.1 Optimal range -0.12 7 8 9 10 11 12 13 14 15 16 17 System capital ratio (% of RWAs) 25
Fund reforms possible macroprudential Divine Coincidence FPC’s principles to reduce structural liquidity mismatch in funds could increase investments in productive finance. 26
FPC’s principles deliver consistency between liquidity and redemption terms Funds should apply a pricing tool, a notice period or a combination of both that reflects the liquidity of their underlying assets 27
Reducing discount rate helps break Tragedy of the Horizon Government reduced discount rate by committing to Net Zero by 2050 and including climate risks in FPC remit. 28
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