5 At the same time, the effect of policy rate changes on household indebtedness is very small. •  The IMF estimates that hiking interest rates by 100 basis points for a year reduces the probability of financial crises by 0.04 to 0.3 percentage point at most. Back to Tinbergen: an enhanced role for regulatory policy So, we are back to where we started: if monetary policy has at best a limited role, what do we do with financial stability? •  As Stefan Ingves put it recently: “We deal with inflation, we keep an eye on the exchange rate, we do our best to reach our inflation target. But that means that somebody else has to deal with the problem we have in our housing market.” 6  And that someone else could well be regulatory policy. And that includes both the oldfashioned microprudential variety as well as the “new kid on the block” – macroprudential policy. Old is gold: microprudential regulation The lesson of the Global Financial Crisis is not that microprudential policy was ineffective in achieving financial stability and therefore we need to look elsewhere. •  The more pertinent lesson was that microprudential regulation – and might I add, supervision – was inadequate and had to be strengthened. 5  Svensson, L (2014), “Inflation Targeting and ‘Leaning against the Wind’,” International Journal of Central Banking, Vol. 10, No. 2, June. 6  “Riksbank Stefan Ingves sees flaws in crisis-busting tools,” Financial Times, 13 September 2015.
•  Do regulatory policies – either the microprudential or macroprudential variety – have an impact on market liquidity or short-term interest rates? The BIS recently convened a working group to assess the impact of microprudential policy on the efficacy of monetary policy. The report concluded that it was difficult to draw firm conclusions. But there were some interesting observations. •  The lending activity of less well-capitalised, higher risk-taking or less liquid banks appears more responsive to a tightening of monetary policy. •  This would seem to suggest that more stringent regulations tend to weaken the transmission of monetary impulses. •  And the transmission of policy rate changes to other interest rates and asset prices may be altered if debt markets become less liquid as a result of regulatory changes. Conclusion Let me conclude by drawing together the main points. •  Microprudential policies are critically important for financial stability and we must get them right. •  But the ability of microprudential policies to achieve financial stability may be dampened by credit cycles that have their roots in broader macro forces. •  Monetary policy matters for financial stability because it affects the credit cycle. To what extent monetary policy should therefore take account of financial stability remains an unresolved matter. •  Macroprudential policy potentially offers a way out by targeting the macro sources of financial instability, leaving monetary policy to focus on price stability. •  But macroprudential policy is neither a panacea nor without cost or distortion.