Why macroprudential policy The conventional thinking pre-crisis was based on two assumptions: •  First, asset prices did not matter much. Central banks therefore focused on consumer prices and placed less emphasis on asset prices. •  Second, if risks in individual financial institutions were well controlled, the financial system as a whole would generally be safe. Regulators therefore focused on the safety and soundness of individual institutions and paid less heed to systemic risk. The collapse of the real estate markets in America and Europe, the breakout of the Global Financial Crisis, and the contagion of risk to seemingly sound financial institutions – against a backdrop of relative macroeconomic stability – showed both assumptions to be wrong. Thus was born macroprudential policy – which focused on the health of the financial system as a whole and its interactions with the macroeconomy, particularly developments in liquidity, leverage, and asset markets. In many emerging market economies, macroprudential policy has become an important complement to monetary policy to help secure economic and financial stability. In Singapore, the focus of macroprudential policy has been to promote sustainable asset prices. Asset prices matter for four reasons. First, volatile asset prices pose a risk to financial stability, especially when a run-up in asset prices is financed by easy credit and accompanied by a build-up in leverage in the economy. When asset prices correct, financial institutions’ vulnerability to default and loss increases. Second, asset price inflation is as distortionary as consumer price inflation.
The credibility provided by the inflation target is a prerequisite for monetary policy to be able to respond so aggressively to the fallout from the crisis. And with inflation being above target almost consistently over this period, it is hard to argue that monetary policymakers have somehow been fixated by inflation. But the forward guidance provided by the MPC makes that support explicit. The primary objective of monetary policy remains the 2% inflation target. The sanctity of that objective is guarded by the two price stability knockouts. But subject to those knockouts and the knockout pertaining to financial stability, our guidance clearly signals the Committee’s intention to maintain a highly stimulatory stance of policy until the economy returns to something closer to normality. Abstracting from the precise details of the thresholds and knockouts, the message to businesses and families should be clear. The MPC intends to keep interest rates low until we have seen a sustained period of strong growth, rising incomes and higher employment, as long as that does not pose risks to either price stability or financial stability. To be clear: that is no different to the approach underlying our policy over the past five years. But forward guidance provides a framework and a language in which that intention can be made plain. A closely related issue is the policy trade-off currently faced by the MPC.