Calibrating macroprudential policy through the financial and monetary cycles

Background

The prolonged period of low interest rates in recent years, followed by the current phase of monetary tightening to combat high inflation, poses important questions for the conduct of macroprudential policy and its interactions within the broader financial system.

The focus of macroprudential policy is to maintain financial stability, while monetary policy is aimed to deliver price stability. These objectives are to a large extent complementary, see ECB Occasional paper No. 272. By mitigating systemic vulnerabilities and building resilience in the financial system, macroprudential policy can dampen the impact of shocks on the real economy and support the role of monetary policy in ensuring price stability. Conversely, price stability is essential for ensuring a stable macro-economic environment and financial conditions.

However, depending on the macro-economic circumstances, the transmission of monetary policy can also have adverse effects on financial stability, and thereby interact with macroprudential policy. For example, low interest rates and loose financial conditions can, particularly after a sustained period of time, lead to enhanced risk taking, higher asset prices, the build-up of leverage and increased indebtedness. These risks may materialize when financial conditions tighten. Moreover, achieving the objectives of price stability and financial stability is more challenging in a situation with elevated systemic risks, slower economic growth, and rising inflation with subsequent higher interest rates.

This workshop will focus on outstanding questions on the impact of the financial and monetary cycle on the build-up and materialization of systemic risks, the calibration of macroprudential policy under these different financial conditions, and how an integrated financial stability assessment could contribute to better alignment of macroprudential policy with the monetary policy stance.

Objectives

This workshop aims to foster and strengthen the dialogue between policymakers and researchers, with a view to enhancing our insights and improve our collective understanding of the effectiveness of macroprudential policies. The workshop will offer an opportunity to share and review empirical studies, state of the art models, and methodological tools in the field of macroprudential policy analysis.

Topics

We welcome all theoretical and empirical contributions on the following topics:

Build-up and materialization of systemic risks through the financial and monetary cycle

It is important to better understand the dynamics and relevant transmission channels of changes in financial conditions on underlying vulnerabilities in the financial system and discuss how this could feed into the macroprudential policy process. It would be interesting to include experiences from previous episodes of boom-and-bust cycles. A financial stability assessment would benefit from empirical models or structured approaches to identify and assess the potential impact of monetary policy on systemic risks and its policy relevance.

Such an assessment would also need to take into account the time dimension, where some effects that could ultimately undermine financial stability only come into full development in the longer term and in a non-linear fashion. Moreover, there can be differences within the phases of the financial cycle whether vulnerabilities in the financial system are still building up or are declining from elevated levels. Also, there are important interactions and feedback loops between macroprudential and monetary policy that can contribute to the potential build-up and materialization of systemic risks that policymakers need to consider.

Calibration of macroprudential policies under different financial and monetary conditions

The design and implementation of macroprudential policies depend on the macro-economic and financial circumstances.

Within a benign economic situation and loose financial conditions, when systemic risks tend to build-up, macroprudential policies can reduce vulnerabilities by increasing the resilience of banks against possible shocks. When financial conditions tighten, macroprudential policy is confronted with potential trade-offs. On the one hand, releasing macroprudential measures could mitigate the impact of the turning economic cycle. On the other hand, it is important to maintain adequate buffers within the financial system to absorb future losses. At the same time, there are differences in impact and scope. Macroprudential policy is less effective in crisis situations when risks materialize. Also, macroprudential measures are mostly tailored towards banks and specific segments of the economy and financial market, whereas monetary policy affects the entire financial system. This could affect the design and implementation of macroprudential policy under different financial and monetary conditions.

Alignment of macroprudential policy with the monetary policy stance

A better understanding of the impact and interaction of changes in financial conditions on vulnerabilities in the financial system would also contribute to an integrated assessment of financial stability and optimal alignment of macroprudential policy with the monetary policy stance.

Timely macroprudential policy can mitigate negative side-effects from accommodative monetary policy. The resulting dampening effect on lending and risk-taking would also support the transmission of monetary policy in containing upward price pressures. Conversely, in an environment of high inflation, releasing macroprudential measures could stimulate lending and thereby interfere with monetary policy in its efforts to contain inflation. Moreover, structural distortions within the financial system can also hinder the effective functioning of the monetary transmission channel and the objective of price stability.

In the context of this workshop, it would be interesting to identify and operationalise how macroprudential policy can contribute to the objective of price stability while containing systemic risks. This could include identifying and quantifying the relevant factors that affect the transmission of monetary policy as well as assessing the potential side-effects of monetary policy from a macroprudential perspective. Such an integrated assessment would also support a comprehensive approach of financial stability within the monetary policy context, without prejudice to the objective of price stability. In the strategic review of its monetary policy strategy, the ECB concluded that “The Governing Council bases its monetary policy decisions, including the evaluation of the proportionality of its decisions and potential side-effects, on an integrated assessment of all relevant factors”.

The organisers welcome submissions from authors working for members of the European System of Central Banks (ESCB), the Single Supervisory Mechanism (SSM) or the European Systemic Risk Board (ESRB), as well as academics, members of other EU organisations or international financial institutions with a professional interest in the issues outlined above.

Interested authors should send either completed draft papers (strongly preferred) or extended abstracts to workshopmacropru@ecb.europa.eu by 18 August 2023 with the email subject “MPPG workshop submission”. All submissions should be in English (in PDF format) and should include an abstract, as well as the name and email address of a nominated author who could present the paper.

Selection process and workshop attendance

The organising committee will review all submissions received by the deadline, looking at their quality, their policy relevance, and the level of interest that they are likely to generate. The committee will also take the overall balance of the workshop in terms of subject matter and approaches into account. All authors will be notified before 15 September 2023 as to whether their papers have been accepted.

In addition to presenters and other speakers, invitations to attend the workshop are also extended to:

• Members of the ESCB Macroprudential Policy Group (MPPG)
• Members of the ESRB Instruments Working Group (IWG)
• Members of any department within the ESCB, SSM and the ESRB who are working on issues related to the theme of the workshop
• Employees of any EU organisation of international financial institution who are working on issues related to the theme of the workshop

Space constraints may mean that organisers need to limit the number of participants from each institution (not including presenters of accepted papers and discussants).

Expenses

The travel and accommodation expenses of all attendees, presenters and discussants representing members of the ESCB, ESRB, EU organisations or international financial institutions should be covered by their own organisations. No participation fees will be charged.

Organising committee

• Carsten Detken, MPPG Co-Chair
• Tomas Garbaravičius, MPPG Co-Chair
• Marco van Hengel, MPPG Secretary
• Evelyn Herbert, IWG Secretary
• Anne McTaggart, MPPG Secretariat