The Grand Unifying Theory (and Practice) of Macroprudential Policy - - PowerPoint PPT Presentation

5 March 2020

The Grand Unifying Theory (and Practice) of Macroprudential Policy

Mark Carney Governor, Bank of England

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

4

Monetary policymaker’s loss function

Central banks won the war only to lose the peace

5

Total UK private non-financial sector credit growth UK Inflation

• 1

1 2 3 4 5 6 7 8 9

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

per cent

60 80 100 120 140 160 180 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

per cent of GDP

Financial crisis powerful reminder of imperative of financial stability

$15 trillion to backstop the system in 2008 UK real wages have only just surpassed their 2007 level Trust in the system collapsed

6

2000 2008 2019

Advent of Macroprudential Policy

Raison d’être is to ensure the financial system supports the economy by

Lending to households and businesses when economic shocks

• ccur

Ensuring downturns not made worse by unsustainable debt burdens

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Advent of Macroprudential Policy

50 100 150 200 250 19982000 02 04 06 08 10 12 14 16 Number of speeches 2 4 6 8 10 12 14 1995-2000 2001-06 2007-12 2013-18 AEs EMEs

And speeches mentioning “macroprudential”

Sources: Bank of International Settlements Sources: Bank of International Settlements

Increasing use of macroprudential measures over time

8

10 20 30 40 50 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Per cent of countries The Great Depression World War I Global Financial Crisis Systemic crises in emerging markets, Nordic countries, Japan, and the US (Savings and Loans)

When it comes to financial stability, success is an orphan

Proportion of countries with banking crises The Panic of 1907

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Grand Unifying Theory of Macroprudential Policy

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 contribute to the growth of the UK economy in the medium or long term. Primary

• bjective

To identify, monitor and take action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK’s financial system Secondary

• bjective

Support the economic policy of Her Majesty’s Government, including its objectives for growth and employment. And…

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Grand Unifying Theory of Macroprudential Policy

Macroprudential policymaker’s loss function

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Monetary Policy vs Macroprudential Policy

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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

Monetary Policy vs Macroprudential Policy

Monetary policymaker’s loss function Macroprudential policymaker’s loss function

13

Intermediate indicators suggest UK risks around standard

14 Sources: BIS, OECD, Datastream, ONS, Bank calculations.

• 6
• 4
• 2

2 4 6 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 Expected change in level of GDP, three years ahead Tail risks increasing Tail risks reducing Macro environment Real house prices HH credit PNFC credit Current account Volatility Capital ratios GDP-at-risk

15

1998 2002 2006 2010 2014 2018

• 10

0.0 0.05 0.15 0.10

• 5

5 10 15 20

GDP-at-risk low Risks increased until 2008 Risks crystallised in the crisis

Real GDP Growth

• Prob. Density

Risks surged during the Great Moderation, now standard

0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14

• 10
• 8
• 6
• 4
• 2

2 4 6 8 10 12 14 Cumulative GDP growth over 3 years (%) Probability density

Risks surged during the Great Moderation, now standard

1997 2007 Latest

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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

Tail risks increasing (GDP-at-risk worsening) as move further right Social cost of financial instability: F (GDP-at-risk)

A A B C

Divine Coincidence generally held in US, Euro area but rarely for UK post-crisis

• 2

2 4 6

• 5
• 4
• 3
• 2
• 1

1 2 Output gap (%) Inflation (%)

• 5
• 4
• 3
• 2
• 1

1 2 3 4 5

• 8
• 6
• 4
• 2

2 4 Output gap (%) Inflation (%)

• 1
• 0.5

0.5 1 1.5 2 2.5 3 3.5 4 4.5

• 4.00
• 3.00
• 2.00
• 1.00

0.00 1.00 2.00 3.00 4.00 Output gap (%) Inflation (%)

UK US EA

19 Sources: Bureau of Economic Analysis, CBO, Eurostat, IMF and Bank calculations.

Pre-financial crisis Financial crisis and after

• 2

2 4 6

• 5
• 4
• 3
• 2
• 1

1 2 Output gap (%) Inflation (%)

• 5
• 4
• 3
• 2
• 1

1 2 3 4 5

• 8
• 6
• 4
• 2

2 4 Output gap (%) Inflation (%)

• 1
• 0.5

0.5 1 1.5 2 2.5 3 3.5 4 4.5

• 4.00
• 3.00
• 2.00
• 1.00

0.00 1.00 2.00 3.00 4.00 Output gap (%) Inflation (%)

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.

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FPC housing tools reduce GDP-at-risk

Changes in consumption relative to income among mortgagors with different LTI ratios (2007-2009)

Sources: Living Costs and Food (LCF) Survey, ONS and Bank calculations

Stressed DSR = 40% 2018 End of scenario (with policy) End of scenario (no policy) 25 50 75 100 Per cent of households Stressed DSR, per cent

Per cent of households with stressed debt-servicing ratios above 40%

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FPC tools have positive net benefits

• 1

1 2 3

Central Upside Boom

Benefits Costs Net Impact Per cent of GDP

Costs and benefits of the housing tools under different scenarios

Sources: FCA Product Sales Database, ONS, Bank calculations. 22

FPC housing tools more efficient than monetary policy to address risks from household debt

23

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

• 6.0
• 5.0
• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 1yr ahead median GDP growth forecast (%) 3yr ahead 5th percentile GDP growth estimate (%, cumulative) 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

• 6.0
• 5.0
• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 1yr ahead median GDP growth forecast (%) 3yr ahead 5th percentile GDP growth estimate (%, cumulative)

Sources: BIS, OECD, ONS and Bank calculations.

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

• 6.0
• 5.0
• 4.0
• 3.0
• 2.0
• 1.0

0.0 1.0 2.0 1yr ahead median GDP growth forecast (%) 3yr ahead 5th percentile GDP growth estimate (%, cumulative)

2004 If FPC housing tools had been in place If monetary policy acted to achieve same reduction in GDP-at-risk

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

• ptimal capital ratio

Estimated net cost of higher capital requirements

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• 0.12
• 0.1
• 0.08
• 0.06
• 0.04
• 0.02

0.02 7 8 9 10 11 12 13 14 15 16 17 System capital ratio (% of RWAs) Estimated cost/benefit of capital

Annual GDP cost of moving away from the appropriate capital ratio (in % of GDP)

Optimal range 11% optimum

26

Fund reforms possible macroprudential Divine Coincidence

FPC’s principles to reduce structural liquidity mismatch in funds could increase investments in productive finance.

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

28

Government reduced discount rate by committing to Net Zero by 2050 and including climate risks in FPC remit.

• 4.7

1.1

• 3.7

2.3

• 4.0

0.9

• 7.9
• 2.8
• 1.2

5.9

• 2.6

2.9

• 10.0
• 8.0
• 6.0
• 4.0
• 2.0

0.0 2.0 4.0 6.0 8.0 GDP outturn United Kingdom China United States Euro area Hong Kong World (PPP)

The Bank’s annual stress test more severe overall than the financial crisis

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GDP Property prices

• 33.0

1.6

• 40.9
• 3.3
• 19.6

4.1

• 25.7

6.6

• 22.3

3.5

• 34.1

11.5

• 44.9

2.6

• 55.0

3.4

• 64.0
• 10.4
• 70
• 50
• 30
• 10

10 30

Property prices (%) UK Residential US CRE UK CRE Euro area Residential US Residential Euro area CRE China Residential HK Residential HK CRE

Latest four-quarter growth (%) 2019 stress test start- to-trough fall (%)

The Bank of England’s single timeless mission since 1694

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“to promote the good of the people of the United Kingdom”

5 March 2020

The Grand Unifying Theory (and Practice) of Macroprudential Policy

Mark Carney Governor, Bank of England