The Foundations of Macroprudential Regulation: A Conceptual Roadmap

58 Pages Posted: 20 Apr 2016

See all articles by Augusto de la Torre

Augusto de la Torre

Columbia University, SIPA; UDLA, Centro de Investigaciones Económicas

Alain Ize

World Bank

Date Written: August 1, 2013

Abstract

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.

Keywords: Debt Markets, Banks & Banking Reform, Emerging Markets, Labor Policies, Economic Theory & Research

Suggested Citation

de la Torre, Augusto and Ize, Alain, The Foundations of Macroprudential Regulation: A Conceptual Roadmap (August 1, 2013). World Bank Policy Research Working Paper No. 6575. Available at SSRN: https://ssrn.com/abstract=2311108

Augusto De la Torre (Contact Author)

Columbia University, SIPA ( email )

420 West 118th Street
New York, NY
United States

UDLA, Centro de Investigaciones Económicas ( email )

De los Granados y De los Colimes, Esquina
Quito, Pichincha
Ecuador

Alain Ize

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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