What can (macro-)prudential policy do to support monetary policy?

BIS Working Papers No 242
December 2007

Abstract:

In the economic environment that has been emerging over the last couple of decades, it is more likely that the occasional build-up of financial imbalances, typically in the form of unsustainable credit and asset price booms, will occur against the background of low and stable inflation, posing a potential threat to financial and macroeconomic stability. This means that the scope for monetary policy to lean against the build-up may be more constrained than in the past, when those imbalances would normally develop alongside rising inflation. This puts a premium on a strengthening of the macroprudential orientation of prudential frameworks, designed to restrain the build up of the imbalances and to make the financial system better able to withstand their unwinding. In this paper, we review the progress made in this direction in recent years. We conclude that there is now a much keener awareness of the importance of a macroprudential orientation but that progress in making it operational, while considerable, has been slower. The main obstacles are of an analytical and, above all, institutional/political economy nature. We suggest ways in which these obstacles could be addressed and underline the potential complementary role that adjustments in monetary policy frameworks could play.

JEL Classification: E30, E44, E52, G20, G28

Keywords: financial stability, price stability, financial imbalances, macroprudential, financial regulation and supervision, monetary policy