By Peter OBIORA InvestAdvocate
Lagos (INVESTADVOCATE)-The International Monetary Fund (IMF) has advocated Macroprudential Policy to aid financial stability.
The IMF came up with this theory in a Paper titled “The Interaction of Monetary And Macroprudential Policies†and made available to www.investadvocateng.com.
According to the Paper, as Macroprudential Policy frameworks are being developed, policymakers are increasingly turning their attention to the relationship between Macroprudential and Monetary Policies.
The IMF Paper affirmed that the newly emerging paradigm is one in which both Monetary Policy and Macroprudential Policies are used for countercyclical management: “Monetary Policy primarily aimed at price stability; and Macroprudential Policies primarily aimed at financial stability†the Paper said.
“The relationship between Monetary and Macroprudential Policies hinges on the “side effects†that one policy has on the objectives of the other and how perfectly each operates in the pursuit of its own primary goal. These interactions can enhance or reduce the effectiveness of each policy in achieving its objectives and therefore suggest the need for coordination†the IMF said.
In its Executive Summary, the IMF said the recent crisis showed that price stability does not guarantee macroeconomic stability and in several countries, dangerous financial imbalances developed under low inflation and small output gaps.
The IMF Paper affirmed that to ensure macroeconomic stability, policy has to include financial stability as an additional objective; but a new objective demands new tools: Macroprudential tools that can target specific sources of financial imbalances, “something Monetary Policy is not well suited to do†the Paper said.
The IMF said effective Macroprudential Policies (which include a range of constraints on leverage and the composition of balance sheets) could then contain risks ex ante and help build buffers to absorb shocks ex post.
“Experience and knowledge on the effectiveness of Macroprudential Policies, their calibrations, interactions among financial distortions and Macroprudential tools, and interactions of those tools with Monetary Policy ones are still limited at this juncture†the IMF said.
The Paper further affirmed with the above caveat in mind, the analysis is that ideally, with Macroprudential Policies perfectly targeting the sources of threats to financial stability, Monetary Policy should remain primarily focused on price and output stability. “That said, even in this ideal world, the conduct of both policies will need to take into account the effects they have on each other’s main objectives†the Paper said.
According to the IMF, the emerging paradigm acknowledges that Monetary Policy is not well suited for assuring financial stability; instead Macroprudential tools should aim to address financial distortions that may lead to a build-up of systemic risk.
The new paradigm recognises that well-calibrated and clearly communicated Macroprudential Policies can contain risks ex-ante and help buffer shocks, and thereby ease the conduct of Monetary Policy during periods of financial stress. “It does acknowledge, however, that Monetary Policy can have effects on financial stability. However, in a world where each policy operates perfectly in attaining its objective, these side effects do not pose significant challenges to the conduct of both policies†the Paper said.
The IMF said the presence of Macroprudential Policy can enhance Monetary Policy’s credibility and transparency, since it’s an additional tool to deal with financial stability.
A credible Monetary Policy framework in turn can help Macroprudential Policy in achieving its objective, by reducing the need for Macroprudential Policy to contain adverse effects of Monetary Policy on financial stability. “When there are synergies, it can be advantageous to assign both policies to the same authority, namely the Central Bank†the IMF Paper said.
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