Macroprudential Policies in Australia: Design and Effects

• Author: Prasanna Gai
• Published date: 01 March 2016
• Date: 01 March 2016
• DOI: http://doi.org/10.1111/1467-8462.12145

Policy Forum: Macroeconomic Consequences of

Macroprudential Policies

Macroprudential Policies in Australia: Design and Effects

Prasanna Gai*

I will focus on the design features of a

macroprudential policy framework, thereby

setting the stage for Adam Cagliarini and

Warwick McKibbin to comment more sub-

stantially on the implications for Australia.

The debate on macroprudential policy is

very much in its infancy, only becoming a

serious topic of contention following the

Global Financial Crisis. On the eve of crisis,

policy-makers were preoccupied with ensuring

that f‌inancial institutions were individually

stable—supervision by f‌inancial regulators

was microprudential in nature. But, there has

been a subsequent relearning of an old verity—

that prudential regulation needs to have a

‘macro’or system-wide element, ref‌lecting the

fact that individual f‌inancial f‌irms do not take

into account the effects that their risk manage-

ment practices have on the balance sheets of

other f‌irms in the f‌inancial system. As Sir

George Blunden (1987, p. 383), one-time

Deputy Governor of the Bank of England,

astutely noted over a quarter of a century ago:

... A bank may consider a course of action it wishes to

take to be acceptable –as it may well be in a limited

context. But the same course might, if widely copied by

other banks, have unfortunate effects on the banking

system as a whole. It is part of the supervisors’job to

take that wider, systemic view and sometimes to curb

practices which even prudent banks might, if left to

themselves, regard as safe.

When considering the design of any policy

framework, it is natural to focus on objectives,

instruments and institutional structure (see, for

example, Haldane 2013). Somewhat unsurpris-

ingly, given the f‌ledgling nature of the macro-

prudential policy debate, there is little

agreement on any of these key design elements.

Objectives. On one interpretation, the aim

for policy-makers should simply be to ensure

the resilience of the f‌inancial system to

macroeconomic f‌luctuations. This would be

in line with Blunden’s implicit notion of

market failure above. The focus would be on

systemic risk and the assessment of its

likelihood and possible impact. Instead of

microprudential supervision, we would have a

system-wide perspective with an attendant

emphasis on stress tests and the war gaming

of tail-event scenarios by policy-makers and

market participants. Critically, such an

approach would strengthen the position of

risk managers in f‌inancial institutions, enabling

them to appeal to the concerns voiced by the

central bank in order to help bring the actions of

bank management to heel.

A more ambitious approach would be to

pursue a dual mandate with a view to protecting

the real economy from swings and cycles in the

f‌inancial system. Prudential regulation thus

becomes a means to improve f‌inancial resil-

ience, as well as attain macroeconomic ends.

For many countries, notably the United

Kingdom and New Zealand, this has been the

preferred approach. Should macroprudential

measures, such as altering capital and liquidity

requirements at business cycle frequencies, be

a distinct arm of macroeconomic policy,

working alongside monetary and f‌iscal policy?

Clearly, in addition to being clear about

instruments, it requires a good deal of

sophistication to achieve meaningful policy

* Department of Economics, The University of Auckland

Business School, Auckland 1010 New Zealand; email

<p.gai@auckland.ac.nz>.

The Australian Economic Review, vol. 49, no. 1, pp. 83–5

°

C2016 The University of Melbourne, Melbourne Institute of Applied Economic and Social Research

Published by John Wiley & Sons Australia, Ltd