Academic journal article NBER Reporter

International Finance and Macroeconomics

Academic journal article NBER Reporter

International Finance and Macroeconomics

Article excerpt

In the years since the severe global financial crisis of 2008, (1) macroprudential policies have attracted interest as a potential additional set of tools to complement ordinary monetary policy, a possible means of counteracting financial market excesses and subsequent crashes.

In the six years since my last report, (2) members of the International Finance and Macroeconomics Program have written over 600 working papers. Many have been published subsequently in leading journals. There is not space here to summarize all or most of them. Instead, I will concentrate on recent research on international macroprudential regulation. All of the working papers in the International Finance and Macroeconomics Program can be found on the program's publications page, http://www.nber.org/papersbyprog/IFM.html.

We have long had microprudential regulation of banks and securities markets. But macroprudential thinking begins with the observation that the whole of the financial system is more than the sum of the parts. A micro-prudential regulation might, for example, limit the loan-to-value ratio for individual mortgages or set capital minimums for individual lenders at levels that are figured by taking the probability of housing price fluctuations as exogenous. Thus it is a "partial equilibrium" approach. A macro-prudential approach recognizes that housing prices are endogenous, and that during a credit-fueled housing boom, the probability of a crash is greater and so regulations on individual borrowers and lenders may need to be set more stringently.

Financial regulators need to think about business cycle fluctuations, and macroeconomic policy-makers need to think about financial regulation. It is not just banks and private financial institutions that were led by a micro perspective into thinking that default probabilities were independent across households, and that therefore treated mortgage-backed securities as virtually riskless. Some regulatory agencies also neglected the correlation across borrowers and so underestimated the possibility that many mortgages could fail simultaneously in a housing downturn.

This survey of recent NBER research on international macroprudential policies is divided into four distinct areas: (1) national prudential policies that address macroeconomic issues in the sense of varying over the business cycle; (2) macroprudential regulation that focuses on the composition of debt, for example treating foreign debt as carrying an extra risk beyond that of domestic debt and perhaps restricting mortgage borrowing in foreign currency more than in domestic currency; (3) a precautionary approach to the national balance sheet with regard, in particular, to foreign exchange reserves; and (4) global liquidity conditions and coordination issues. This survey places some emphasis on findings from emerging markets.

1. Cross-country Differences in the Use of Macroprudential Policies

One root source of capital market imperfections is the need for borrowers to have collateral in order to prove their creditworthiness. (3) A debtor who is up against a collateral constraint may be forced to sell assets ("fire sale"), driving down the market price and thereby putting other borrowers up against their own constraints. Javier Bianchi and Enrique Mendoza show how overborrowing carries a pecuniary externality because private agents do not internalize how the price of assets used for collateral responds to collective borrowing decisions. (4) Their model suggests that financial innovation may have played a role in the financial crisis of 2008-09. (5)

Many observers warn of the moral hazard dangers of bailing out creditors or lenders in a financial crisis. But if the time-consistent system features government intervention during the deleveraging phase of the cycle, it is appropriate to take this into account beforehand. Restrictions or taxes on overborrowing during the boom phase of the cycle will reduce the likelihood or pay the costs of bailouts during the bust phase. …

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