"In practice, the authorities would be asked to continuously address the micro-level objective and the system-wide one. This is probably what makes the parallel with monetary policy not entirely satisfactory. In the case of macroprudential regulation and supervision the same policy instrument – bank capital – would be used to address both microeconomic purposes (reducing the probability of default of individual institutions) and macroeconomic goals (reducing system-wide risks and procyclicality), violating Tinbergen’s rule. Admittedly, micro- and macro-stability are compatible most of the time, but they may conflict in some circumstances.
Another drawback of discretion is that warnings and recommendations may have adverse effects, with the warnings possibly turning into self-fulfilling prophecies for example. This might imply significant political pressure on macroprudential authorities.
On the other hand, under rule-based frameworks any policy reaction would be left to pre-defined automatic mechanisms and triggers. This would avoid time-inconsistency; moreover, authorities would be forced to identify the (still subjective) optimal balance between the micro and macro objectives once for all. Unfortunately, the design of the set of rules may be extremely difficult, particularly for a brand new policy, which should be applied world-wide. Moreover, rules are subject to Goodhart’s law: the informational content of a targeted variable would be vanished once it becomes part of a (publicly known) rule.
So, can a combination of rules and discretion be a viable solution also for macroprudential supervision?"
Wednesday, February 24, 2010
I'd like to recommend a very interesting article on rules vs discretion in macroprudential policies by Massimo Libertucci and Mario Quagliariello.
Posted by ls at Wednesday, February 24, 2010