In the words of James Mackintosh, writer of the Financial Times column “The Short View,” a not insignificant number of stocks in the S&P 500 have valuations “that rely on belief in a financial fairy.” Margin debt is pushing up against all-time records. And, in the bond market, narrow spreads between corporate and Treasury debt reflect lower risk premia on top of already abnormally low nominal yields. We must monitor these indicators very carefully so as to ensure that the ghost of “irrational exuberance” does not haunt us again. QE spillovers As you well know, the effects of unprecedented monetary easing in the U.S. and other advanced economies do not stop at international borders. They spill over onto the rest of the world. Record-low interest rates engineered by central bankers have led investors to seek higher returns elsewhere, generating massive inflows of capital into emerging market economies (EME), including Mexico. Let’s not forget that capital flows to EMEs were large even before the crisis. That said, they rose further as quantitative easing gained momentum in the U.S. and other nations adopted similar policies. For example, U.S. capital stock as a share of home-country GDP rose from 11 percent to 17 percent in Brazil and from 18 percent to 25 percent in Mexico between 2008 and 2012. Capital flows were increasingly made up of portfolio investment rather than direct investment during this time.
Building stronger macroprudential frameworks  The ESRB has promoted stronger macroprudential frameworks across the Union. Specifically the ESRB has issued recommendations to encourage national legislators to establish macroprudential authorities within their jurisdictions. Its Handbook on Operationalising Macroprudential Policy in the Banking Sector embodies practical information on how to set policy using the newly-established powers. The Handbook sets out best practice on an instrument by instrument basis, suggests indicators to guide their use, and outlines the legal framework governing them. It also details potential spillovers. Where it judges that best practice is not being followed, the ESRB can use “soft law” to issue recommendations on an “act or explain” basis to mitigate financial stability risks and curb spillovers. For example, last year the ESRB gave guidance to national macroprudential authorities on how to set countercyclical capital buffer rates. The ESRB will follow up that guidance with a published assessment of implementation in 2016 Q3. With macroprudential policy still in its adolescence, the ESRB is helping it to mature. BIS central bankers’ speeches  1  Recent ESRB studies have evaluated the case for using margining to counteract pro-cyclical behaviour in derivatives and securities financing transactions. And this year, the ESRB assessed the value of including macroprudential buffers within the leverage ratio framework. The Bank of England has followed this approach to ensure that the leverage ratio complements the risk-weighted capital framework in a way that makes it robust to cyclical and structural risks.