This article explores methods for achieving both economic stability and financial stability, emphasizing that cooperation between central banks and financial regulatory authorities plays a crucial role.
Traditional monetary policy aims to stabilize prices and promote economic stability by utilizing policy interest rates. When the economy overheats, central banks seek to cool it down by raising policy interest rates. As market interest rates also rise with policy rate hikes, credit supply contracts due to reduced lending to households and businesses. This contraction in credit supply reduces demand within the economy, stabilizing prices and cooling the economy. Conversely, during economic downturns, the opposite process is employed to stimulate the economy. Through this, central banks maintain economic stability and pursue sustainable growth.
Traditional economics, which views finance solely as a transmission channel for monetary policy, held that financial supervision policy should focus on microprudential policy—achieving financial stability by ensuring the soundness of individual financial institutions. This perspective stems from the recognition that finance, not being a direct means of production, does not influence economic growth in the long term as it does in the short term, and from the Efficient Market Hypothesis, which posits that asset markets do not experience bubbles where prices surge beyond intrinsic value. Microprudential policies utilize regulatory tools with a preventive nature regarding the soundness of individual financial institutions. An example is minimum capital adequacy regulation, which sets a lower limit on a financial institution’s capital to prepare for future losses.
Thus, in traditional economics, a dualistic approach dominated, viewing financial stability as achievable through financial supervision policies and price stability through monetary policy. However, following the global financial crisis, the collapse of the financial system and the spread of economic instability prompted a reevaluation of this traditional approach. A consensus emerged that central banks’ low-interest-rate policies, aimed at stimulating the economy, could cause financial instability through asset price bubbles, thereby undermining economic stability. Furthermore, as financial institutions grew larger, the failure of individual firms could trigger systemic collapse, making the size of financial institutions a new risk factor for financial stability. Consequently, it became clear that existing policies could not secure financial stability, and that financial stability, alongside price stability, was an essential requirement for economic stability.
As a result, the view gained mainstream acceptance that economic stability must be achieved through the complementary interaction between financial supervision policies—which now incorporated macroprudential policies alongside microprudential ones—and monetary policy aimed at price stability. This shift became increasingly important as the complexity and interdependence of the financial system grew. For instance, the globalization of financial markets necessitates international cooperation and coordination to prevent financial instability in one country from spreading to others. Against this backdrop, financial regulatory authorities are striving to establish international regulatory standards to enhance the stability of the financial system.
Macroprudential stability refers to a sound state where the likelihood of crisis is low at the financial system level, not just at the individual financial firm level. Macroprudential policy encompasses activities such as regulation and supervision that pursue the soundness of the financial system. Macroprudential policy is logically grounded in the ‘fallacy of composition,’ which holds that microprudential stability is not a sufficient condition to guarantee macroprudential stability. Macroprudential policy differs from microprudential policy in that it pursues the soundness of the financial system through preventive regulation targeting systemic risk factors.
To effectively achieve the objectives of macroprudential policy, it is necessary to introduce policy instruments that account for the correlation between economic fluctuations and financial system risk factors. Financial system risk factors exhibit procyclicality. That is, during economic booms, financial firms increase lending, expanding credit supply, which causes asset prices to surge sharply. This, in turn, further fuels the economic boom. Conversely, during recessions, the opposite situation occurs. A policy tool that can mitigate this is the countercyclical capital buffer system. This system requires financial institutions to build up additional capital, known as a buffer, on top of their minimum capital requirements during periods of economic overheating. This curbs excessive credit expansion. Conversely, the accumulated buffer capital is used as a lending resource during economic downturns, ensuring sufficient credit supply.
Furthermore, to enhance the effectiveness of macroprudential policy, financial authorities continuously monitor the soundness of the financial system using diverse data and analytical tools. This enables the early detection of potential risk factors within the financial system and the implementation of appropriate policy responses to mitigate them. For instance, efforts are underway to assess the resilience of the financial system through scenario analysis techniques such as stress testing, and to design more effective regulatory policies based on these assessments.
Overall, it is crucial to achieve both economic stability and financial stability through a complementary approach combining traditional monetary policy and financial supervision policy. This is achievable through close cooperation and coordination between the central bank and financial regulatory authorities, enabling the pursuit of sustainable economic growth.
