Macroprudential policy and financial imbalances

Abstract

Whereas the use of macroprudential instruments has been growing since the global financial crisis, there remains a need for verification of their overall and relative effectiveness. Most extant work has focused on the impact of macroprudential policy on house price rises and credit growth. We contend that it is crucial also to address the effectiveness of macroprudential policy and its instruments in reducing the build-up of financial imbalances in the wider economy. We focus on the credit-GDP gap, which besides being recommended to trigger the Basel III countercyclical buffer, is also widely seen as a key indicator of financial imbalances and predictor of financial crises. Accordingly, we assess the effectiveness of macroprudential instruments in reducing the credit-to-GDP gap, determining which instrument(s) would be more effective globally and according to the development of the country’s economy. We use a GMM-difference approach to estimation of determinants of the level of the gap for 43 advanced and emerging market economies using quarterly data over 2000q1-2013q4. GMM-difference with the change in the gap as dependent variable, and two estimates of panel OLS with fixed effects are used as robustness checks. We find a number of tools to be effective including loan-to-value and debtto- income ratio regulations, notably when the credit gap is positive. In comparison with other extant work, a similar range of tools are effective as for the measures of real credit growth, although the focus of existing policy on bank and household lending, a subset of the total which is captured by the credit-to- GDP gap, raises some potentially important issues.