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Reserve Bank outlines issues for possible new policy tools

The Reserve Bank  is considering new macro-prudential policy tools being developed globally to curb extreme macro-financial imbalances, such as asset price bubbles, according to an article in the Reserve Bank Bulletin.They could be sustained within t

Mon, 05 Jul 2010

The Reserve Bank  is considering new macro-prudential policy tools being developed globally to curb extreme macro-financial imbalances, such as asset price bubbles, according to an article in the Reserve Bank Bulletin.

They could be sustained within the existing powers of the Reserve Bank Act and they may support the effectiveness of monetary policy.

But they will have to be carefully managed and considered for unintended consequences, according to the article written by Grant Spencer, the bank's deputy governor and head of macro-financial stability.

It would be necessary to establish appropriate key performance indicators and deal with policy overlaps, Dr Spencer said.

"Dealing with these potential policy overlaps will certainly be facilitated by having one small full-service central bank managing monetary policy and all prudential policies," he said.

The RBNZ would also have to assess if a rule-based approach currently preferred by the Basel Committee was appropriate for New Zealand conditions, he said.

Existing key performance indicators for the macro-financial stability function, as published in the bank's statement of intent, would need to be reviewed.

Macro-financial stability policy focuses on imbalances, such as asset bubbles, balance of payments deficits and excessive debt levels, which have potential to stress the financial system.

The policy area has become a focus on central bankers in the wake of the global financial crisis.

The article says the macro-financial stability function has existed within the Reserve Bank for a number of years and the bank has produced financial stability reports six-monthly since October 2004.

If additional macro-prudential instruments are adopted with the intent of better achieving the RBNZ's financial system stability objective, the existing powers under its act are likely to be adequate.

"The post-global financial crisis changes to both micro- and macro-prudential policies will need to be carefully managed."

In December, the Basel Committee released consultative documents generally referred to as the Basel Three proposals.

They identify a range of options that might be used to reduce the damage from an asset market collapse and potentially also assist in stabilising the credit cycle.

Of these macro-prudential options, it seems clear that the financial accounting standards will change, both in the US and internationally.

"While some of the proposed Basel Three changes will be required for New Zealand to conform with basic international standards, the new policies should be tailored as far as possible to New Zealand's specific circumstances.

"The changes will also need to be carefully assessed with regard to unintended consequences and efficiency costs as well as the system stability benefits they are intended to achieve," Dr Spencer said.

The central bank has a monetary policy function aimed at price stability and a financial stability function aimed at promoting the maintenance of a sound and efficient financial system.

Dr Spencer notes that from the mid-1990s onward, central banks began to broaden this macro-financial stability role, in particular by monitoring the macro-financial system more intensively and producing regular financial stability reports.

While the Reserve Bank retained and indeed broadened its prudential supervision role, it expanded its macro-financial stability function, including a formal mandate to regularly monitor macro-financial stability.

A more explicit macro-approach to prudential policy is relatively new for most countries and its potential usefulness is uncertain.

"To date, the objectives being proposed for macro-prudential policy in the larger economies have tended to focus on promoting greater financial system resilience rather than on using instruments to dampen cycles in credit or asset markets," he said.

However, a number of smaller open economies have adopted a more ambitious approach to macro-prudential policy with the explicit intent of dampening cycles in credit and asset prices.

The motivation for this approach has been the difficulty some of these countries have had in controlling domestic financial conditions in the face of easy global liquidity or large swings in commodity prices.

The macro-prudential tools currently being considered by the major economies are related to the creation and dissipation of additional buffers on the balance sheets of banks through the credit cycle.

Following the recent experience, the Reserve Bank now puts greater weight on the importance of maintaining liquidity in key benchmark financial markets.

Mon, 05 Jul 2010
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Reserve Bank outlines issues for possible new policy tools