Since we are in the wake of such a financially destructive boom and bust, the desire of global policymakers to minimise the risks inherent in future booms is understandable. However, policymakers must ask themselves whether we are in danger of relying too much on time-varying macroprudential policies. To my mind, time-varying macroprudential policy instruments have profound limitations.
Firstly, the effectiveness of these instruments assumes that the policymaker can detect accurately the build-up of systemic risk. Systemic risk is, however, hard to measure. While there are some reasons to believe that we can provide early warnings of dangerous buildups in risks (Dell’Ariccia et al., 2012; Drehmann et al., 2012), there is little evidence that these warnings are reliable.