In the first two posts of this series (here and here) I have argued that the case for borrower-based macroprudential tools is sound and that, while they appear to be effective, they have distributional costs. I finished the previous post mentioning that the distributional benefits are much more difficult to estimate than the costs, although there are good reasons to think that they are there. In this post, I want to consider what this asymmetry means for how these policies are conducted. One way to do so is to compare them with one of the main roles of central banks: monetary policy.

I like this comparison, because monetary and macroprudential policies are more similar than one might expect. For instance, we have been discussing how macroprudential policy can prevent some households from buying their first house. But the same is true with monetary policy: higher interest rates increase mortgage rates, which can prevent lower-income households from accessing this type of lending.

One difference worth noting is that monetary policy affects both potential and current borrowers, at least in countries with a substantial proportion of adjustable-rate mortgages (or with short fixation periods like the U.K.). Borrower-based macroprudential policies fall much more directly on potential borrowers or, more precisely, on people who want to buy a house via borrowing.

Monetary policy is therefore also distributional. We have a substantial body of work on this question, both theoretical and empirical (Auclert, 2019; Cloyne et al., 2020). Changes in interest rates redistribute income and wealth between households depending on their indebtedness, asset holdings, and sources of income. In particular, borrowers with adjustable-rate debt tend to lose when interest rates go up, while net savers tend to gain. Through this direct cash-flow channel, the effect can reverse when interest rates fall. This symmetry is much less evident when macroprudential limits are introduced. A household prevented from borrowing to buy a house today is not automatically compensated when the limit is relaxed several years later; by then the household might not be financially constrained anymore.

But there is another key difference between the two policies. It is subtle, but I would argue that it has significant consequences: the feedback available to policymakers and the public.

Monetary policy targets inflation. Inflation figures are published frequently, and the target is usually explicit. We can therefore observe whether inflation is above or below the target and whether it appears to be moving in the right direction. Note that this does not allow us to determine scientifically (i.e., to “prove”) whether the central bank is succeeding. For that, we would need to observe a counterfactual world (or estimate one) in which the central bank had followed a different monetary policy and compare the resulting inflation. Nevertheless, we can observe inflation and form a reasonably-informed view about whether the central bank is doing its job.

But what do macroprudential policies target? Typically it is to improve the positions of households during a recession, and potentially also to smooth the credit cycle. Where is the feedback? How can we know that it is achieving its results? The truth is that we cannot easily know. What we can see is that these tools have immediate distributional costs, making it difficult for lower-income and first-time-buyer households to access mortgages, for some uncertain benefits.

The objectives of macroprudential policy are more difficult to observe. Borrower-based tools are intended to limit the build-up of systemic risk, make households more resilient during a downturn, and, potentially, smooth the credit cycle. Authorities can observe household indebtedness as well as mortgage defaults. But these are intermediate outcomes. The ultimate benefit might be a recession in which fewer households default, fewer families are forced to cut their consumption sharply, and the fall in house prices is less severe that it would otherwise have been.

How do we know whether this has happened? As stated before, it is not easy to know. We may need to wait for a sufficiently large negative shock. Even when the shock arrives, typically several years later, we still need to estimate what would have happened without the policy. And while no severe downturn occurs, the benefits remain almost entirely counterfactual.

This produces a fundamental asymmetry. We can see many of the costs immediately. We can identify households that cannot obtain the mortgage they wanted, buy the house they wanted, etc. The benefits, by contrast, are delayed, contingent, and difficult to (empirically) attribute to the policy. A household that avoids default during a future recession may never know that a macroprudential intervention helped protect it; the same with an local market that sees a drop of house prices of 1% instead of the 2% that would have experienced without the macroprudential policy.

This does not mean that the benefits are not there. Nor does it mean that evaluating these policies is impossible. But it does mean that their evaluation requires very detailed data and careful empirical analysis. The necessary data tend to be collected by central banks. Therefore, central banks are often in the best position to do this evaluation. But this presents a problem: can we leave the assessment to the same institution designing and implementing the policy? The incentives might be distorted (Fabo et al., 2021 in the context of QE) and some central banks are cutting back on research. Independent scrutiny is therefore important not only for determining whether these tools work, but also for the democratic legitimacy of the powers exercised by central banks. Yet such scrutiny is possible only if outsiders can access the relevant data. This will be the subject of the fourth and final post.