Macroeconomists and financial sector experts need to talk to each other. Such communication is important to help identify and measure systemic risks as well as to coordinate and/or conduct macroprudential policies—rules that reduce instability across the financial system.
The creation of financial stability committees, including in Latin America, have been a forum for precisely this—working together to share information about evolving risks, develop monitoring and mitigating tools, and to define the decision-making authority, accountability, and communication to the general public. But institutional design and governance of these councils differ across countries.
A recent conference in Lima, Peru—organized by the IMF and the Central Reserve Bank of Peru—brought together experts from advanced countries and Latin American regulators that have established financial stability committees to share experiences and discuss early lessons about the functions and governance of these committees.
Financial stability committees involve all major stakeholders—including central banks, ministries of finance and financial supervisors—but governance structures differ across countries. These differences relate to existing (pre-crisis) arrangements, different trade-offs with other policies (monetary, microprudential), as well as legal and institutional constraints. Central banks play a central role in the coordination of stability mandates, owing to their expertise, credibility, and independence, but in many countries it is the ministry of finance that has the lead—due to their role in the budget and legislative processes. The debate on the best governance structure has not yet been settled in the profession.
In two countries in Latin America—Chile and Mexico—the Ministry of Finance chairs the financial stability committee, but the central bank has an important role as an advisor or in leading the analytical work. Brazil, in contrast, has followed a model closer to the United Kingdom, where a dedicated committee within the central bank coordinates the activities of all supervisory agencies. Besides sharing data and conducting analytical studies, these committees could have higher powers, such as asking other agencies to “comply or explain” why the committees’ recommendations were not followed, thus increasing transparency and accountability.
Monetary and Macro-prudential Policies
Another issue that was debated in the conference was the interaction between monetary and macroprudential policies. In principle, many participants supported a separation of both policies, except when a well-articulated cost-benefit analysis shows the advantages of “leaning against the wind” of financial (in)stability for the monetary authority. For example, an early tightening of monetary policy to contain increases in household debt may thwart an economic recovery—with the costs of increased unemployment outweighing the marginal benefits of reduced debt. However, to articulate and/or estimate these costs and benefits is quite challenging, and may lead to inaction or aggressive action (as seen in Sweden in the recent past). Developing the analytical skills for this type of analysis is central to the effectiveness of these committees.
More broadly, since both policies affect financial conditions, and these analytical skills may be in short supply in emerging markets, a stronger coordination between both macroprudential and monetary policies may be warranted for some countries.
Three key issues emerged from the discussions and presentations of Latin America’s experience:
- First, there are concerns about the legal uncertainty of actions undertaken by the financial stability committees for the heads of agencies bound by their own legal frameworks. Clear objectives, mandates, and powers for members of these committees are thus critical to prevent this legal uncertainty.
- Second, most financial stability committees focus on macroprudential policies and have an unclear role in crisis resolution or when financial stability is threatened, whereas public perceptions may relate more to the committees’ role in crisis than in normal times.
- Third, from an emerging market perspective, issues like the impact of capital flows volatility, foreign exchange and asset price dynamics on balance sheets and financial stability require a central role for central banks—even if the lead in the committee is with the ministry of finance.
Regardless of the institutional design, it is critical to build an interface between macroeconomists and financial sector experts. More discussion and debate on these issues can contribute to building the right institutions for financial stability.