macroprudential policy. old is gold : microprudential regulation the lesson of the global financial crisis is not that microprudential policy was ineffective in achieving financial stability and therefore we need to look elsewhere. • the more pertinent lesson was that microprudential regulation – and might i add, supervision – was inadequate and had to be strengthened. svensson, l ( 2014 ), “ inflation targeting and ‘ leaning against the wind ’, ” international journal of central banking, vol. 10, no. 2, june. “ riksbank stefan ingves sees flaws in crisis - busting tools, ” financial times, 13 september 2015. bis central bankers ’ speeches and the microprudential framework has indeed been strengthened post - crisis. the basel iii reforms will go quite some way to make banks more resilient and financial systems safer. • the quantity and quality of capital have been increased. • there is for the first time, a global liquidity standard. • there will soon be a direct cap on bank leverage. • systemically important banks will be subject to higher loss absorbency and more intrusive supervision. besides these reforms, i would add that traditional microprudential limits that apply “ through the cycle ” are just as important in helping to maintain financial stability. if volatility in the real estate sector has repeatedly been shown to contribute to financial imbalances and distress : • does it not make sense to put limits on financial institutions ’ exposures to real estate? • does it not make sense to require that loan - to - value ratios for property loans be less than 100 %? • does it not make sense to require the loan underwriting process to incorporate an assessment of the debt service ratio? i do not know if the global financial crisis could have been avoided if interest rates in the us had been higher in the preceding years as some have argued. • i do suspect though that if there had been prescribed loan - to - value ratios and debtservice ratios, the sub - prime problem may not have grown to such proportions. • but there are many others in this room who are better placed to judge that. old wine in new but bigger bottles : macroprudential regulation even as we re - discover the virtues of microprudential policies, we realise they may not be sufficient in the face of overwhelming exuberance and risk - taking. • this is where macroprudential policy comes in. • macro

link or no link? ” bis working papers, no. 346, bank for international settlements, may. bis central bankers ’ speeches incentive for both borrowers and lenders to take more risk. the consequent build - up in leverage leads to financial instability. 4 • jeremy stein puts it succinctly : “ monetary policy is fundamentally in the business of altering risk premiums ”. third, since monetary policy affects risk - taking and the credit cycle, which in turn affect financial stability, monetary policy should therefore take account of financial stability. • jeremy stein argues that since economic agents will find ways to circumvent regulatory measures to control risk - taking, it is better to use monetary policy to “ get in all of the cracks ”. • conceptually, this amounts to augmenting the taylor rule with an additional term to capture deviations in financial variables from their equilibrium values. • monetary policy has a role in “ leaning against the wind ” of financial stability risks. while the first two propositions are gaining credence and traction among policymakers, the third proposition is heavily contested. • the fact that monetary policy has an impact on financial stability does not necessarily mean that it should directly seek to achieve it. monetary policy and financial stability : uncomfortable bedfellows? let me offer two reasons why operationalising a financial stability role for monetary policy may be difficult. leaning against winds from opposite directions? first, conflicts could arise between the price stability and financial stability objectives. • financial cycles are typically longer than business cycles, and the two cycles may diverge. • the interest rate appropriate for price stability may not be consistent with financial stability. • how does one lean at the same time against two winds blowing from opposite directions? one reason why the winds might blow from opposite directions, especially for emerging economies, is the role played by international liquidity and capital flows. • philip lane has detailed the strong inter - linkages between global liquidity conditions, international debt flows, and domestic credit conditions. • maurice obstfeld argues that because of the impact of financial globalisation, monetary policy carries a big burden trying to achieve both financial stability and macroeconomic stability. the experience of emerging asia during 2010 – 2013 is illustrative. • asian economies were broadly in full employment with low inflation and some downside risks to growth from the eurozone crisis. borio, c and zhu, h ( 2008 ), “ capital regulation, risk - taking and monetary policy : a missing