For example, cross-sectional instruments are less likely to conflict with monetary policy than with the cyclical dimension of macroprudential policy. And instruments aimed at a narrow range of financial institutions or agents will be easier to focus on financial behaviour rather than macroeconomic factors. In general, it is desirable to use instruments with a narrower focus to address specific problems, as they can be better tailored to the problem and will have fewer unintended consequences on the real economy and on other policy objectives. However, there will be times when instruments with a broader scope will be desirable – for example, when there is a danger that developments in the financial system will enable agents to circumvent more narrowly focused instruments. The ability to circumvent instruments forms one of the challenges for macroprudential policy. The effectiveness of macroprudential policy could be strained when the build-up of risks (for example, an asset price bubble) in the financial system justifies significant policy intervention to contain the risks but the prevailing macroeconomic conditions do not justify a similarly aggressive monetary policy. While the macroprudential agency may tighten policy substantially to increase market interest rates (to dampen the asset price bubble), doing so will increase the incentive to circumvent the intervention (for example by borrowing from institutions outside the scope of macroprudential policy, such as foreign lenders). This implies that the effectiveness of time-varying macroprudential instruments will vary depending on the arbitrage opportunities available to borrowers and lenders in the economy.

The macroprudential mandate is likely to be broad in scope, as system-wide risks can arise in a wide range of ways and from a wide range of sources. Consequently, the range of macroprudential instruments must be equally broad in scope. Discussions of macroprudential instruments usually emphasise the need for instruments that operate in two dimensions: the time or cyclical dimension, in which instruments are designed to counteract financial multipliers/ accelerators that amplify cycles; and the cross-sectional dimension, in which instruments are required to isolate or dampen the transmission of problems across the financial system. While it is important that the macroprudential agency has control over instruments to prevent and mitigate system-wide risks, it is not essential for the agency to implement these instruments itself. The macroprudential toolkit is likely to include instruments used for other policy objectives and not implemented by the macroprudential agency (for example, capital requirements and insurance premiums). Overlap between policy areas The overlap between different policy areas is one of the major challenges to the design of effective governance arrangements. Responsibility for using instruments that can be used for multiple policy objectives is more complicated and policy-setting is more difficult as policymakers must consider the unintended impact of their instruments on other policy objectives and the unintended impact of other policy-makers’ instruments on their own policy objective. The use of an instrument for one objective may conflict with or amplify the effect of instruments used to achieve a different policy objective.