That being so, the question is what to do about the possibility that, occasionally, stimulating demand to offset macroeconomic damage from the crystallisation of one set of imbalances can fuel a new set of imbalances. The question is posed most pressingly about the US. But, in the UK’s recent monetary history, one finds a parallel in the debate in the early 2000s about whether or not there were limits to a strategy of stimulating domestic demand – principally household spending – in order to offset the effects on the medium-term outlook for inflation of pronounced weakness in external demand and business investment after the bursting of the Dot.Com bubble. Seen in that light, the central question becomes whether the authorities should have tools to check the evolution of stretched balance sheets, particularly in the financial sector, in the face of robust credit growth and asset price appreciation. This goes some way towards making the case for the “cyclical” elements of macroprudential policy. And that, of course, is a key destination for me this evening. When, more than a decade ago, the Draghi Report exhorted domestic and international authorities to monitor and maybe manage national balance sheets, the term “macroprudential” was used only by Andrew Crockett, Claudio Borio and their colleagues at the BIS.22 Now it is a buzzword – planned in the West and used already in parts of Asia and Latin America. Macroprudential policy: tempering but not obstructing financial liberalisation Plainly finance got out of hand. Not for the first time in history.
The respective slopes of these two schedules depend on the relative impact of the policy rate and the macroprudential tool on aggregate demand and on the quantity of credit. A well-chosen and well-designed macroprudential tool is one that has a relatively large effect on the quantity of credit but only a modest impact on aggregate demand. That would generate a relatively flat FS schedule. Moreover, since changes in policy rates also affect aggregate demand through routes other than the credit channel, such as the exchange rate, it seems reasonable to assume that the PS schedule is relatively steep. That is the configuration of relative slopes shown in the Chart. Provided the two schedules do not coincide, both price and financial stability objectives can be achieved simultaneously. With this configuration, it is natural to assign the monetary instrument to the pursuit of price stability and the macroprudential instrument to the pursuit of financial stability. Moreover, with these slopes and this assignment, no active co-ordination in the setting of the instruments is strictly necessary: a process whereby each instrument is set independently, taking the other as given would converge on the equilibrium, A. That said, appropriate co-ordination and information exchange is desirable to achieve it efficiently and is facilitated in the real world by housing the MPC and the FPC in the same institution, with overlapping memberships, and the scope to meet jointly when required. Some sorts of shocks will involve a tightening in both instruments.