Macroprudential Policies: A Primer

This post is a simplified summary of The Promise and Peril of Macroprudential Policy By Barry Eichengreen, Project Syndicate, August 7, 2015. It may be a helpful article about macroprudential policy.

Monetary policy is mainly about keeping unemployment and inflation low. But it would be nice if it could also be used to restrain asset price bubbles (because such bubbles invariably burst, causing severe financial crises and recessions). Given that during asset price bubbles people tend to feverishly buy assets with borrowed money, the central bank could simply slow its lending of newly printed money to banks and thereby cut off the bank lending fueling bubbles.

And yet, until the financial crisis of 2008, central bankers had been unwilling to take on the task of fighting asset price bubbles. Why? When asset prices start to rise, it is hard to know whether the rise in prices is sustainable or a bubble that is about to burst; by the time it is clear that a rise in asset prices is a bubble, it is usually too late. So, given that bubbles are hard to detect quickly, it was thought that instead of trying to stop bubbles from forming central banks should let them form, but move in quickly after they burst to make the inevitable recession as painless as possible (by implementing expansionary monetary policy to reduce interest rates and thereby stimulate the economy).

Unfortunately, the crisis of 2008 has shown that while detecting an asset price bubble in a timely manner may be hard, letting a bubble develop and cleaning up the mess after it bursts may be even harder.

So, should central banks set aside their hesitation about fighting bubbles, and restrict the money supply in order to raise interest rates whenever they see what looks like the beginnings of an asset price bubble? Not so fast; it is a hard trick to pull off. The Swedish central bank tried to do just that in 2010 but ended up creating a recession. "Before long, Sweden had succumbed to deflation, from which it is still struggling to recover."

The best approach may be to use the central bank's control over the interest rate for the traditional purpose of keeping unemployment and inflation low, and to develop separate tools to tackle asset price bubbles. The use of these separate tools is called macroprudential policy.

The two main tools of macroprudential policy are (procyclical) capital requirements and (countercyclical) loan-to-value ratios.

Capital Requirements: The money that a bank lends comes from its depositors (deposits), its lenders (debt), and its owners (capital). If the monetary authorities require banks to rely more on their owners' capital for the money they lend, the banks would tend to be more cautious about lending. Therefore, raising capital requirements during the initial stages of an asset price bubble may squelch bank lending to the crazed buyers driving up asset prices, and thereby stop a bubble from forming.

Loan-to-Value Ratios: Suppose you wish to buy a house and a bank lends you 95 percent of the value of the house, leaving you to pay only the remaining 5 percent. That would make buying a house easy. On the other hand, if the monetary authorities impose a loan-to-value ratio of 75 percent, the demand for houses would shrink. In this way a bubble in home prices can be avoided if the loan-to-value ratio is reduced when house prices start to rise in a bubble-like manner.

Unfortunately, although these macroprudential tools are fine in theory, they have problems of their own: "The Bank of Spain’s attempt to implement adjustable capital requirements for banks, ... did little to deter aggressive lending during the country’s property boom. Once a mania gets underway, the temptation to join is simply too strong." Also, discouraging banks from lending to home buyers by reducing loan-to-value ratios may simply encourage other unregulated lenders to step in and fill the gap.

So, where does all this leave us? Although the new macroprudential tools are imperfect, it is probably better to have more tools than less. The central bank can use its control over interest rates for the traditional purpose of keeping inflation and unemployment low, and it can use macroprudential policies to stop asset price bubbles from destabilizing the economy.

Medical Education in India

Just read a fascinating article on the dysfunctional nature of India's medical education system: India’s private medical colleges and capitation fees by Jeetha D’Silva, British Medical Journal, January 21, 2015.

Many of the horrors of the system -- such as the huge capitation fees collected in defiance of the law -- could, in hindsight, have been predicted by an average sentient being. Why then was such a system put in place to begin with? What was the nature of the debate that led to the current system? I wish I knew the history of the system.

On the issue of reform, I agree with the opinion expressed in the final paragraph by Dr. Samiran Nundy, chairman of the department of surgical gastroenterology and organ transplantation at Sir Ganga Ram Hospital, Delhi: There should be a common entrance exam and a common exit examination for all who wish to be recognized as doctors in India.

The government should lift all restrictions on fees; price control is not working. And the system of government medical colleges has been a disaster. In 2014, "616,982 [candidates] took the All India Pre Medical Test to qualify for 2503 “open” places". And this is in a country of more than a billion people!

After eliminating all restrictions on fees, the government should then regularly publish data for every medical college -- government and private -- on the fees it charges, the profile of its admitted students' scores in the common entrance exam, the number of admitted students who took the common exit exam, and the profile of their scores in the common exit exam. This information will help prospective students to do some comparison shopping.

The other problem is how to help students from poor families pay the steep fees without helping the rich or those who would eventually leave for lucrative careers in other countries. Here's my proposal: After a student from a poor family is admitted to a medical college (government or private), for every fee her family pays, the government will deposit an equal amount into a special bank account in the student's name. The student's family will be able to decide how the money is invested (in stocks, bonds, whatever). After the student's education at the college ends -- successfully or not -- the family will be able to withdraw the money in the special account, not all at once, but in staggered annual amounts over the period equal to a typical Indian's professional life, with the proviso that each such fixed withdrawal would be allowed only if the student was an Indian resident during the year or no longer alive.

I am aware that my proposal has glaring weaknesses. Please feel free to criticize; I promise my feelings will not be hurt.

Here's a mystifying NPR report on a community in upstate New York where women are pressured to not drive, apparently on religious grounds. Some questions: Why do religious people so often feel the need to impose their preferences on others? And why do they feel the need to segregate themselves into communities in which public morality can be imposed? Why are they so unwilling to consider religion to be a private matter? Why is it that the more punctiliously religious some people are, the more likely they are to be doing things that seem totally incomprehensible to me?

The Libertarian Utopia of Hazaribagh

This is an informative -- and transfixing, frankly -- report on the environmental impact of the tanning industry in the Hazaribagh area of Dhaka, Bangladesh, by Tania Rashid, a talented young Bangladeshi-American reporter for Vice News. Libertarian utopians in the West who decry environmental regulations -- and regulations in general -- should take note.

A Report on Rape in Bangladesh

The occurrence of rapes and gang-rapes in India have received a great deal of global attention. But if this report by Tania Rashid of Vice News is to be believed, the situation in neighboring Bangladesh may not be a whole lot better: "A recent UN report revealed that one in eight men in rural Bangladesh admit to having committed rape." (This Vice News report is revealing on multiple levels and bears repeated viewing. I was stunned by how astonishingly riverine and verdantly green Bangladesh looks in the video. Also priceless was the utter contempt Rashid expresses as she leaves a meeting with the head of a mosque.)

What Charlize Theron's Good Fortune Tells Us About Wages

I don't know whether the higher remuneration that Charlize Theron was able to obtain using information revealed by the Sony hack corrects an unfair outcome or makes a fair outcome unfair. But it does show how wages depend on bargaining power and the availability of information -- two factors that are generally ignored in undergraduate courses that discuss wages. (In the utopia described in those courses, the contribution of each worker is easily measured and known to all. And each worker gets paid what they contribute. I teach that material, but -- in my defense -- I do feel guilty about it afterwords.)