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The foundations of macroprudential regulation : a conceptual roadmap, Volume 1
 
Author:de la Torre, Augusto; Ize, Alain; Country:World;
Date Stored:2013/08/15Document Date:2013/08/01
Document Type:Policy Research Working PaperSubTopics:Emerging Markets; Economic Theory & Research; Debt Markets; Banks & Banking Reform; Labor Policies
Language:EnglishRegion:The World Region
Report Number:WPS6575Collection Title:Policy Research working paper ; no. WPS 6575
Volume No:1  

Summary: This paper examines the conceptual foundations of macroprudential policy by reviewing the literature on financial frictions from a policy perspective that systematically links state interventions to market failures. The method consists in gradually incorporating into the Arrow-Debreu world a variety of frictions and sources of aggregate volatility and combining them along three basic dimensions: purely idiosyncratic vs. aggregate volatility, full vs. bounded rationality, and internalized vs. uninternalized externalities. The analysis thereby obtains eight "domains," four of which include aggregate volatility, hence call for macroprudential policy variants grounded on largely orthogonal rationales. Two of them emerge even assuming that externalities are internalized: one aims at offsetting the public moral hazard implications of (efficient but time inconsistent) post-crisis policy interventions, the other at maintaining principal-agent incentives continuously aligned along the cycle. Allowing for uninternalized externalities justifies two additional types of macroprudential policy, one aimed at aligning private and social interests, the other at tempering mood swings. Choosing a proper regulatory path is complicated by the fact that the relevance of frictions is likely to be state-dependent and that different frictions motivate different (and often conflicting) policies.

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