RECOMENDACIONES

Macroprudential policy is needed both for financial markets and businesses since they demonstrate an aspect of the economic concept known as the “tragedy of the

commons.” There is no single “owner” of the financial system and consequently, in the 78 lead-up to the financial crisis, banks and other financial institutions developed products and operated in such a way as to threaten the stability of the system as a whole. Financial stability meets the definition of a “public good” in that there is no rivalry and no exclusivity in that financial stability is indivisible, in that its benefits are available to all “its enjoyment by one jurisdiction does not reduce the amount available to another country”.79In

economic terms the benefits accrued to the financial institutions but the risks were not internalised and, in many instances, fall on the state and taxpayers.

This risk to the stability of the system is magnified by the ability of banks to create money. Left to their own devices banks will create money using short-term debt 80 instruments. Consequently, it is important that “central banks should not be reluctant to deploy [their various] tools...in an effort to contain excessive private money creation,” It is 81

First articulated in 1833 by William Foster Lloyd, ‘Checks to population’, (reprinted in 1980) Population

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and Development Review, Vol. 6, No. 3, 473, 483,using the example of overgrazed common land where while there is a collective, as opposed to an individual, interest in its conservation nothing is done

Supra note 76, (Lastra, ‘Systemic risk’), 313. See also Joel Trachtman, ‘The international law of financial

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crisis: spillovers, subsidiarity, fragmentation and cooperation’, (2010) 13 (3) Journal of International Economic Law, 719-742, on the failures of regulatory “fragmentation” in the context of global risks, (pages 723-725)

For example, the development of the discounted bill of exchange as a form of money created by banks

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turned business and commercial promissory notes into negotiable instruments. These documents, once endorsed by a bank of high standing, could be used, in turn, as security for more credit. The use of these short-dated financial instrument by one of the largest and most reputable UK bank of its time, to finance long-term infrastructure projects resulted in the last major bank run prior to Northern Rock when the bank failed in 1866, Geoffrey Elliott, The Mystery of Overend and Gurney, (Meuthen, London, 2006)

Jeremy Stein, ‘Monetary policy as financial stability regulation’, (2012), The Quarterly Journal of

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the special function of banks to create money as they carry out the process of “maturity transformation”. The transformation of maturity can be reversed as long-term assets held 82 by banks are then, in turn, changed, via securitisation, into shorter-term commercial paper liabilities which can be sold to another financial institution and then used as part of another maturity transformation process and so on. In parallel, banks will transform risk; both by increasing and decreasing risk.The extent and the speed of this process are at the heart of concerns with the stability of the financial system.

This section next considers the role of central bank in relation to asset price rises and their control. There has been a conceptual change of policy in this area among many central banks since the financial crisis but no clear determination who, if anyone, should carry out this task. This section examines how the financial system is threatened by the “tragedy of the commons”. While macroprudential policy sets a series of objectives it is in practice, defined by the “tools” employed and these, in turn, are conditioned by a range of factors including the institutional structures and political environment.

As mentioned earlier, part of the rationale for macroprudential policy is the need to limit rapid asset price growth. However, the view of central banks prior to the financial crisis was not to target asset price rises since it was impossible to determine whether these were due to systemic imbalances or changes in economic fundamentals. More recently, 83 this view was reiterated by the Governor of the Banque de France who said that asset prices should not be targeted by central banks. The latter should be limited to two broad

“At the heart of banking is ... maturity transformation, or more simply, banks borrow at a shorter term and

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lend at a longer term in respect of the duration of their deposits and loans. This is the essence of banking....This is a benefit to the economy and society because it allows longer-term borrowing by companies and by all of us to buy houses. But it makes banks inherently illiquid.” ‘Financial Stability – objective and resolution’, speech by Andrew Bailey at the Pro Manchester Business and Professional Services Conference, Manchester, 17th March 2011. See also Philip Lowe, Deputy Governor of the Reserve Bank of Australia on ‘The transformation in maturity transformation’ at the Thomson Reuters’ Third

Australian Regulatory Summit, Sydney, 27th May 2015

Supra note 73, (Bernanke and Gertler), and Bernanke and Gertler, ‘Should central banks respond to

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movements in asset prices?’, (2001) The American Economic Review, Vol. 91, No. 2, 253. However, Stefan Gerlach considers thatthere is something special about accelerations in the growth of the price of property, supra note 77.This is supported by research by Bordo and Olivier, supra note 77. However, it is difficult to identify a housing bubble early enough, or at all. Charles Bean, ‘Asset prices, financial imbalances and monetary policy: are inflation targets enough?’, speech at BIS, 29th March 2003. He also mentioned that achieving “price stability may be associated with heightened risks of financial instability.” See also John Taylor, ‘The financial crisis and the policy response: an empirical analysis of what went wrong’, (2008), A Festschrift in Honour of David Dodge’s Contributions to Canadian Public Policy. Ottawa: Bank of Canada, 1. However, this is disputed by Ben Bernanke, ‘Monetary policy and the housing bubble’, speech at the annual meeting of the American Economic Association in Atlanta, 3rd January 2010

objectives:“price and financial stability”. The governor was critical of some who have 84 “suggested including asset prices in the index targeted by the central bank.” He saw this “as a distinctly sub-optimal solution, as it would essentially amount, in practice, to moving to a situation with one instrument, monetary policy, aiming at a combination of two

objectives, price and financial stability.” This can be contrasted with the views of Padoa-85 Schioppa who considered that monetary policy, working in tandem with microprudential supervision and backed by the availability of emergency liquidity, would be sufficient to ensure financial stability. He saw “banking as a system” in which the “pursuit of financial 86 stability occupies a ‘land in between’ monetary policy and prudential supervision”. As 87 mentioned earlier, the relationship between monetary policy and macroprudential policy is considered in the next chapter.

As mentioned, it is clear that macroprudential policy is, at best, a set of broad objectives. It is the variety and use of a range of macroprudential “tools” which defines this form of regulation. In contrast, microprudential regulation is based on promulgating rules, both substantive and procedural, for regulated firms coupled with effective supervision of how firms comply with these requirements. The next chapter considers a subset of the full macroprudential “tool-kit”, their effectiveness and the limitations on their use. However, this thesis advocates both the use of conduct of business rules as part of the set of

macroprudential tools as well as limiting asset price growth by substantially increasing the supply of housing.

Before considering this it is necessary to look at the structure of the financial system and what is meant by “financial instability” and to consider whether macroprudential policy can reduce the risk of this developing in way which is difficult to control.

Christian Noyer, ‘Monetary policy and macroprudential policy” speech at a conference on ‘The future of

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monetary policy’, Banca d’Italia, Rome, 30th September 2010 Ibid, (Noyer)

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Tommaso Padoa-Schioppa, ‘Central banks and financial stability’, speech in Jakarta, 7th July 2003. See

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also Tommaso Padoa-Schioppa, ‘Central banks and financial stability: exploring the land in between’ in V. Gaspar, P. Hartmann and O. Sleijpen (eds), The transmission of the European financial system, (European Central Bank, Frankfurt, 2003)

Tommaso Padoa-Schioppa, Regulating finance: balancing freedom and risk, (Oxford University Press,

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