Predictability is about ensuring that the flow is gradual across economic scenarios, including scenarios that are quite different from our central forecast. Achieving this predictability is complicated by uncertainty about agency MBS principal repayments, an issue I’ll summarize briefly. To an extent, mortgage payoffs are driven by the white noise of life, such as homeowners selling their homes as they find new jobs in different areas of the country, have children, or retire, and in the process pay off the mortgage on their old house. There is some uncertainty about how social and demographic factors like these will impact the housing market over the long term, and this therefore creates uncertainty in long-term MBS prepayment forecasts. Over the short term, however, by far the greatest source of aggregate uncertainty in mortgage principal repayments relates to refinancing, the process by which homeowners get a new mortgage with a better interest rate, and pay off their old one in the process. Refinancing results in existing agency MBS, containing the old higher-rate loans, being paid off more quickly, along with greater issuance of newly-minted agency MBS containing the new, lower-rate loans. Homeowners are incentivized to refinance when mortgage rates decline below the rate on their current loan. In contrast, most market participants expect longer-term interest rates, including primary mortgage rates, to rise over policy normalization, and that therefore mortgage refinancing activity will be modest. As a result, most expect mortgage principal repayments to run below the level of the redemption cap set by the FOMC.

Without absolute clarity about the objectives of any macro-prudential policy framework and the policy rule necessary to deliver these objectives, expectations will not adjust and policy will be impotent. Any lack of transparency or failure of communications is likely to inhibit seriously the effectiveness of macro-prudential policy. Sixth, because macro-prudential policy is new in most developed countries, there are understandable concerns that policymakers’ knowledge of the transmission mechanism of policy is incomplete and imperfect. The model of the credit cycle developed here offers some grounds for optimism. Signalling is the key transmission channel. Quantitative estimates of the effects of, for example, higher capital ratios on banks’ cost of credit provision have wide confidence intervals (BIS (2010)). But this may not be fatal if macro-prudential policy by-passes these channels and works by acting, first and foremost, through expectations. Seventh, the credit cycle is increasingly an international phenomenon, as well as a national one. Credit spillovers occur across borders as well as across banks. This suggests macroprudential policies need also to have an international dimension if they are to tackle credit externalities. This is recognised in the macro-prudential policy framework currently being discussed by the international regulatory community (BIS (2010)). This framework includes an explicit reciprocity provision. For example, judgements on local credit conditions determine the amounts of capital to be held by international banks on their exposures in  24  BIS Review 168/2010  those countries. This reciprocity feature should help to reduce the arbitrage risks posed by the internationalisation of the credit cycle.