This is best illustrated by considering the relationship between macroprudential policy and monetary policy. Monetary policy instruments can affect financial stability Monetary policy instruments can have an effect on financial stability. Recently, it has been proposed that monetary policy can affect the build-up of risk in the financial system through the “risk-taking channel”, an independent and previously unrecognised part of the transmission mechanism. 8 There are a number of ways in which (loose) monetary policy is said to encourage risk-taking. Low interest rates can encourage investors to substitute lowyielding, safe assets for higher yielding, riskier assets – the “search for yield”. Investors (such as pension funds) may make this substitution in the hope of attaining returns that match their commitments. 8  The concept of a risk-taking channel was introduced by Claudio Borio and Haibin Zhu in “Capital regulation, risk-taking and monetary policy: a missing link in the transmission mechanism?” BIS Working Paper No.268, 2008. BIS central bankers’ speeches  7  Alternatively, investors may be encouraged to take greater risks if they perceive that monetary policy is being used asymmetrically – that is, that the policy rate is reduced aggressively in the event of a sharp fall in asset prices but the policy rate is not used to address sharp increases in asset prices. Another, more indirect channel, is formed by a feedback loop that amplifies asset price increases and causes banks to increase their holdings of risky assets.
This may be more difficult to achieve for international tools that require agreement between multiple national policy makers. Macroprudential policy needs to be operational soon It is therefore clear that vulnerabilities are emerging as countries recover from the crisis and it is important that national authorities are soon able to implement macroprudential policies to address those risks. Leading the development of formalised macroprudential policy arrangements are the European Systemic Risk Board, which will hold its inaugural meeting in just two days, and the Financial Stability Oversight Council in the US, which held its first meeting in October 2010. But many other countries are thinking seriously about how to implement and conduct macroprudential policy in their jurisdictions. Governance arrangements for macroprudential policy A vital aspect of the macroprudential policy framework will be the design of the governance arrangements. They will determine how the different elements of the framework are brought together and will influence how macroprudential policy interacts with other policy areas. Governance arrangements should be effective in three broad areas; they must ensure that the macroprudential decision-maker (the “macroprudential agency”) has: (i) a clear mandate;  managed to avoid the fiscal consolidation currently seen in many other EU countries. One reason for Sweden’s robust public finances is that it had to implement a programme of fiscal consolidation in the mid1990s, following the Swedish banking crisis.