The macroprudential model back on the financial catwalk; Policy ideas that seem terribly old fashioned to one generation have a habit of being reborn

May 22, 2014 6:08 pm

The macroprudential model back on the financial catwalk

By Gillian Tett

Policy ideas that seem terribly old fashioned to one generation have a habit of being reborn

Sartorial fashion is cyclical. Every few years, certain trends that had dropped out of style become hot on the catwalk again – meaning that ideas are constantly recycled.

Something similar may be under way in central banking too. Five decades ago, central bankers assumed that it was sometimes sensible to use targeted regulatory controls to create a healthy economy and financial system.

But then, from the 1980s, it became fashionable to presume that macroeconomic management sat in a different silo from financial regulation: the former was dominated by debates about inflation targets and interest rates; the latter focused on bank supervision.

Now the pendulum is swinging again. This week, Mark Carney, governor of the Bank of England, warned that the rapid pace of UK house price rises could threaten the British recovery, prompting speculation that the BoE will begin to tighten policy before long.

But if so, it is unlikely to rely exclusively on the tools it has used in the past decade – namely its power to set interest rates or to influence the rate at which money is created. Instead, the bank’s Financial Policy Committee might well turn to so-called macroprudential measures, which are intended to prevent financial excess. For example, it could impose loan-to-value caps for mortgage lending, or require banks to hold bigger capital buffers against certain types of loan.

Such regulatory meddling fell out of favour in the late 20th century. But since the 2008 financial crisis policy makers have discovered what they once knew but seemed to have forgotten: that macroeconomics cannot be divorced from finance and that it is sometimes difficult to steer the economy through interest rates alone.

Thus, when emerging market countries such as South Korea introduced measures to prevent excessive “hot money” investment inflows a couple of years ago, they labelled these “macroprudential” measures, where previously they might have called them “capital controls”.

Then, last year, countries such as New Zealand, Norway and Switzerland borrowed the label, too, to describe moves they were taking to combat domestic credit bubbles. Now big western countries are catching the wave and linking financial regulation to macroeconomic management: aside from the BoE, the European Central Bank is promoting macroprudential measures, too, and the idea is being debated at the US Federal Reserve.

What should investors make of this? One obvious lesson is that progress in policy making tends to follow the pattern of a Hegelian dialectic; ideas that seem terribly old-fashioned to one generation have a habit of being reborn with subtly fresh twists.

Another lesson is that these paradigm shifts do not always start with economists – or big central banks.

Think, for example, about how the last great shift occurred in relation to inflation targeting. Back in the late 1980s, the central banks of New Zealand and Sweden started experimenting with this out of frustration with the shortcomings of the previous central bank paradigm of targeting money supply. It was only later that the concept spread to countries such as the UK, at which point academic economists created an intellectual framework to justify this new mantra.

As Paul Tucker, former deputy governor of the BoE, recently observed, this pattern is playing out again: ideas that started in places such as New Zealand are spreading, and academics are scrambling to catch up. For what is striking about the new macroprudential fashion is that there is still relatively little intellectual scaffoldingsurrounding it, although groups such as the International Monetary Fund are now trying to put one together.

A third point to note is that central banks (and economists) would do well to be a little humble about their ideas. It is clear that policies such as inflation targeting, money targeting or macroprudential management can all be useful. But they all have potential shortcomings. Setting policy purely to target consumer price inflation does not work well if the biggest danger is an asset price bubble; but meddling in financial markets is not always as effective as raising interest rates to curb bubbles either. What limited evidence there is suggests that earlier experiments with macroprudential policy have produced mixed results

The one thing that is clear is that, whenever there is blind faith in any single paradigm, that paradigm will eventually fail. The fact that the BoE and others are relearning that finance and macroeconomics need to be analysed together is welcome, if long overdue.

But do not expect this new macroprudential paradigm to be a magic wand. Just remember the history of inflation targeting; or think of flares.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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