Determining Optimal Macroprudential Instruments

A survey of macroprudential policy research reveals that several policy instruments have the potential to mitigate systemic risks from credit cycles. Although there is no conclusive agreement on the optimal policy, some insights can be obtained that narrow down the choices of effective regulatory measures. Capital requirements are a limited means to counter systemic risk. There seems to be an optimal degree of capital ratios: too extensive capital requirements can be as welfare decreasing as too little. Further, capital regulation must address securitization of mortgages in order to be effective. The possibility for banks to move credit positions to unregulated intermediaries creates moral hazard. The literature fails so far to produce specific recommendations to this extent. Also, bank closure policies are an important piece in the set of macroprudential instruments. Although a bail out policy may be ex post optimal, it creates moral hazard in the form of excessive risk-taking. Finally, monetary policies alone are not able to address risks from credit bubbles effectively. Low loan-to-value ratios may combat excessive housing price appreciation and debt bubbles from homeownership. As a difficulty for policy makers, macroprudential policies appear to be optimal when set in a countercyclical manner and depending on the source of shocks. Cycles and the nature of shocks are, however, difficult to detect in advance