Claudia Buch: Evaluation and macroprudential policy
Speech by Prof Claudia Buch, Deputy President of the Deutsche Bundesbank, at the Annual
meeting of the Verein für Socialpolitik, Münster, 7 September 2015.
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Ladies and gentlemen
The theme of this year's annual meeting of the Verein für Socialpolitik is "Economic
development - theory and policy". The evaluation of development aid projects has a
relatively long tradition - from which many other policy areas may benefit. Much greater use
could still be made of research findings on the evaluation of the efficiency and effectiveness
of public projects and economic policy measures. I wish to illustrate this using
macroprudential policy as an example.
Why are development aid projects frequently evaluated? For one thing, financiers expect
accountability on the impact of their financial assistance. For another, researchers can often
contribute to the project design. That lets them incorporate the features needed for an ex
post impact analysis while the project is still on the drawing board. Ex ante planning allows
evaluation data to be collected in a manner conducive to maximising the reliability of
econometric identification. Tackling a stimulating research topic without nagging questions
about the identification strategy boosts the likelihood of being published. That's an incentive
for researchers to get involved in evaluation and the key to putting evidence-based economic
policymaking into practice. And that, ladies and gentlemen, is what I think we need to see
more of in other policy fields.
But the actual impact of measures is often just as uncertain outside the realm of
development aid. In many cases, the projects in question are much larger still and relate to
entire countries - tax policy, education policy, health policy - and not forgetting financial
market regulation. The question for me is this: how can we make sure that these areas, too,
are subject to greater and, above all, scientifically proven evaluation?
There are two hurdles to overcome, in my view, but neither of them are insurmountable. The
first is the inadequate data pool, the second a frequent absence of a need for the
scientifically-based evaluation of policy measures.
As Deputy President of the Bundesbank, one of my areas of responsibility is financial
stability. This includes macroprudential policy. We still don't know all that much about the
impact of macroprudential policy measures right now. The available evidence is very sparse;
it is often no more than cross-sectional analyses across different countries derived from short
time series. We are therefore working to create the conditions for superior policy evaluation.
1. What is financial stability?
Macroprudential policy is a relative newcomer to the policy space. In some respects, the
level of knowledge and experience in this area is roughly on a par with that in the field of
monetary policy some years ago. The specific policy goals are difficult to quantify,
transmission channels are often unknown, and the data sets and analytical methods need to
be developed.
Why do we need macroprudential policy? The world of traditional banking regulation offers
little scope for curbing the systemic repercussions of financial crises because it focuses
primarily on the economic health of individual market participants.
For the most part, microprudential analysis is based on the assumption that the financial
system as a whole is stable, that markets are liquid and that market players that run into
difficulties will not have a significant detrimental impact on the financial system or the
economy as a whole.
But that view is a short-sighted one, because past episodes in which seemingly isolated
microprudential risks were either misinterpreted or underestimated have taught us that our
work needs to take a broader perspective. Risks to the stability of the financial system can
arise if large institutions create negative externalities (too big to fail), if institutions are highly
interconnected (too connected to fail), or also if many smaller institutions are exposed to
similar types of risk (too many to fail).
This key takeaway from the recent financial crisis prompted the establishment of
macroprudential authorities around the world that focus on risks that might threaten the
financial system as a whole. Let's begin with the mandate and the objective. The objective of
macroprudential policy is to safeguard financial stability. Financial stability is the term used to
denote the financial system's ability to perform its key macroeconomic functions - particularly
so in the event of unforeseen events, periods of stress or structural upheaval.
For the costs of financial crisis can be heavy - not only with regard to the amount and
duration of real economic losses but also concerning the often considerable fiscal costs. It is
not about completely curbing risks and fluctuations in the financial markets but instead about
reducing negative externalities caused by the distress of individual institutions or market
segments.
Here, we need to ask ourselves how "financial stability" can be measured and concrete
indicators formulated. After all, even though the situation appears to be stable, the creation of
systemic risk through moral hazard can jeopardise financial stability. That's why reducing
misguided incentives and increasing the size of risk buffers in the system are key to
maximising financial system stability. From this general definition, indicators - such as
property prices, risk premiums or credit growth - are derived in the policymaking process and
used to assess financial stability.
2. Macroprudential policy in Germany
Main responsibility for financial stability in Europe rests at the national level. In Germany, the
Financial Stability Committee (FSC) was created in 2013 as a national macroprudential body.
It comprises representatives of the Federal Ministry of Finance, the Federal Financial
Supervisory Authority (BaFin), the Bundesbank and the Financial Market Stabilisation
Agency (FMSA), which has observer status.
The Bundesbank plays a special role in the FSC, by injecting its experience of
macroeconomic analyses and of banking supervision. In a nutshell, the Bundesbank is the
FSC's "analytical arm". What is more, besides preparing the Committee's annual report to
the German Bundestag on the status of financial stability in Germany, the Bundesbank also
drafts warnings and recommendations by the FSC and assesses their implementation.
Of course, merely establishing macroprudential institutions does nothing to boost financial
stability - rather, what are needed are a strategy for macroprudential policy and the
appropriate instruments.
The internationally agreed Basel III regime that is currently in force already contains a
number of instruments designed with macroprudential matters in mind. For instance,
systemically important banks have to hold more capital than other institutions, primarily as a
way of countering the moral hazard ("too big to fail") caused by their size.
Another instrument is the countercyclical capital buffer, or CCB, which is designed to boost
financial system resilience by tightening capital requirements in times of increased lending.
The CCB is scheduled to become legally effective in Germany on 1 January 2016, though no
decision has been taken hitherto as to its exact level.
However, these instruments are no more than a rudimentary toolkit for combatting systemic
risk emanating from real estate markets. And yet the recent financial crisis clearly
demonstrated just how important the residential property market is for financial stability. A
number of other countries are already using dedicated macroprudential instruments for the
real estate market; Germany, by contrast, does not have the requisite legal basis as yet. To
close this gap, the FSC submitted a recommendation to the Federal Government on 30 June
2015 proposing the creation of new macroprudential instruments for the residential real
estate market. I would expressly point out, however, that this step does not mean that these
instruments will be deployed or activated.
The FSC is recommending four instruments: a cap on the loan-to-value (LTV) ratio, a cap on
the debt-to-income ratio/debt-service-to-income ratio as well as an amortisation requirement.
An LTV ratio, for instance, specifies a minimum amount of equity capital which a debtor must
contribute to a residential real estate financing transaction. These instruments have two
objectives. One is to reduce the likelihood of overindebtedness and thus of crises. The other
is to stem the effects of crises, should they occur anyway, by means of larger risk buffers.
If these instruments are activated in the future, an ex post impact analysis should be carried
out. That calls for sound data, which is why the Committee's recommendation asked for the
creation of a legal basis for the collection of granular data and a mandatory ex post impact
analysis.
3. How do data fit into the equation?
But what are "sound data"? The lessons learned from the US experience tell us that a
loosening of credit standards for subprime households can be one of the major root causes
of financial crises. A development of that kind can only be identified if granular data are to
hand.
The Bundesbank has responded to the need for higher-quality and above all granular data by
establishing its Research Data and Service Centre (RDSC).1 A new project has been
launched to administer and link microdata and macrodata, and to make them available to
both Bundesbank and external researchers. At present, ten members of staff are busy
capturing, compiling and maintaining these data, which are being used in 120 projects.
Internationally, too, a host of initiatives have been kick-started in an effort to close data gaps.
For instance, Europe's central banks will, in the coming years, be setting up AnaCredit, a
comprehensive database which will help them to link loan-level data and banks' balance
sheet data. That kind of data pool would open up a wealth of analytical opportunities that we
could use in a great many areas.
The Bundesbank's RSDC is specifically looking to establish close ties between research and
policy guidance. The idea is for researchers to be given access, free of charge and with a
minimum of red tape, to the data - subject, of course, to the appropriate data protection
requirements. So by increasing the availability of sound data, we are going a long way
towards dismantling the first of the two hurdles we face in this field.
However, data alone are insufficient to tell us how effective an economic policy measure has
been. This measure, rather, needs to be embedded in a structured impact study. Applying a
set of objective and structured procedures specified upfront can yield information on
effectiveness and potentially increase the likelihood that a policy measure will be accepted.
They prevent situations in which inconvenient findings go unpublished or access to the
necessary data is obstructed.
The guidelines adopted by the Verein für Socialpolitik are an important and a necessary step.
At their heart are the general principles of methodological quality, transparency, objectivity
and independence. But to make sure data shortages do not scupper evaluations, the data
capture process should be planned well ahead of introduction and be enshrined in law. This
modus operandi not only cuts the cost of policy evaluation, but also diminishes the risk that
the necessary data cannot be provided at all ex post.
And last but not least, making evaluation mandatory would be a step in the right direction.
This procedure is widely followed internationally, one example being the Office of
Management and Budget in the United States, which is required by law to evaluate
legislation with a substantial financial impact, while in Switzerland, policy evaluation is even
enshrined in the national constitution. In this connection, let me revisit the FSC
recommendation I referred to earlier. It contains a regular impact analysis which can also be
verified by third parties.
Ladies and gentlemen, impact analyses are an important tool for finding out more about the
efficacy of policy measures, quantifying costs and benefits, and flagging unexpected
sideeffects. They require guidelines for decision-makers and researchers. However, they can
also only work in a forward-looking policy environment which aims to enshrine policy
evaluation in law and which provides the necessary financial and data resources.
It is important for researchers to contribute their expertise and ideas, and play a part in this
process. More often than not, bright ideas are the "by-products" of stimulating debate with
peers. That's the reason why we're all here today, so without further ado, I will bring my
speech to a close.
Thank you for your attention.