Independent Economists Group Warns of Uncertainty over Macroprudential Policy

TheCityUK’s Independent Economists Group (IEG), chaired by Andrew Sentance, Senior Economic Adviser at PricewaterhouseCoopers, has warned in a new report that uncertainty over the use of macroprudential measures and the timing of interest rate rises pose risks to the UK economy.

According to the IEG, while macroprudential tools offer significant potential, policymakers must exercise caution in implementing measures which could undermine the financial stability they are designed to ensure. At the same time, interest rate rises must be controlled to ensure they do not result in imbalances which threaten the economic recovery.

In the new report, ‘The role of macroprudential policy in the policy framework’, the IEG considers the potential of new macroprudential tools available to policymakers and regulators to promote stability in the financial system by managing risks from linkages in the system. While it recognises that these policies have real potential, the IEG also warns that how these measures will work in practice is still largely unknown.

Andrew Sentance, Chairman of the IEG, commented:

There’s no doubt that macroprudential measures are a potential new weapon in policymakers’ arsenal, particularly when it comes to managing asset bubbles and controlling systemic risk. But as with anything new, to a large extent these measures are untried and untested. This policy uncertainty creates certain risks, so it is vital that policymakers consider the likely impact their implementation will have.

The IEG report uncovers a number of areas of uncertainty around the implementation of macroprudential measures, including:

  • The challenge regulators face in knowing when to implement macroprudential measures, given a lack of knowledge about the lag between implementation of a measure and it taking effect
  • How regulators will manage to identify any problems in a timely manner
  • Minimising the risks of macroprudential measures simply driving instability from one jurisdiction to another
  • Whether macroprudential measures will be able to combat future problems – in other words, the possibility that they could be outpaced by financial innovation
  • The possibility of a conflict with other monetary, fiscal and microprudential policy initiatives 

Andrew Sentance added:

UK policy-makers appear keen to deploy macroprudential tools where they see threats to financial stability – for example in the housing market. But we must recognise that even though these measures have been used previously - before markets globalised in the 1980s - that was a very different environment and as such does not provide much of a guide as to how they will work today. We do not know how quickly measures will take effect or how effective they will be, when and how to use them most appropriately, or what their impact will be on fiscal or monetary policy. As policymakers deploy these measures it will also further the need for effective surveillance, as the international nature of financial markets means instability can easily cross regional boundaries.

The new IEG report also looks at the potential timing of a rise in UK interest rates, and the likelihood of a rise this calendar year. There were divided views on the desirability of a rate rise before the end of 2014, and on the likelihood of the first rate rise before the upcoming general election – though the weight of opinion was against a near-term rise.

Andrew Sentance commented:

There are divided views among City economists on the right timing for the first rises in interest rates and on when that will happen. But if the first rise is delayed too long, there is a risk that the MPC will have to act quickly after the election with a succession of rapid rises in order to ensure price stability and sustainable economic growth.

A full copy of the IEG report is available below