One of the main lessons of the last crash is that central banks and financial regulators need more ways to reduce the risk of the next one. Announcements by the Bank of England on Thursday serve as a reminder, six years later, that this lesson hasn't yet sunk in.
Many central banks, led by the U.S. Federal Reserve, have innovated boldly when it comes to monetary policy. They have pumped money into the financial system. They have provided banks with emergency loans. They have started providing "forward guidance" in an attempt to stabilize markets. Some even pay negative interest rates on reserves as a way to encourage private lending. Many countries have overhauled their financial regulatory systems as well.
There is a third category of innovation, however -- known as macroprudential policy -- that has lagged behind. It shouldn't.
As the name suggests, macroprudential policies are a kind of hybrid: financial regulations attuned to the condition of the system as a whole, rather than the soundness of particular banks or other institutions.
Here's an illustration. Authorities can make any individual bank less likely to fail by demanding that it use more capital and less debt to finance its lending. (That's generally a smart policy.) The macroprudential approach would go further -- say, by varying the amount of required capital according to the economic cycle. Or regulators could cap loan-to-value ratios for mortgage loans, for instance, not because particular lenders were at risk from reckless lending but because the system as a whole was tolerating too much leverage and inflating a house-price bubble.
The U.K. is a prime candidate right now for strong macroprudential policies. It has low inflation, economic slack and moderate growth -- suggesting that interest rates should stay low for the moment. But the U.K.'s mortgage borrowers look increasingly overextended and, in and around London, there's every appearance of a house-price bubble. On Thursday, the Bank of England introduced new macroprudential restrictions supposedly aimed at that imbalance. They are notable mainly for their timidity.
The BOE told banks to make sure that new borrowers could still afford their loans if interest rates rose three percentage points within five years, and that mortgages of more than 4.5 times borrowers' incomes should be limited to 15 percent of new lending. For now, neither rule makes any difference. About 10 percent of existing U.K. mortgage loans are at 4.5 times income, so the banks have room to expand such lending further. Yet even at the current 10 percent (in London, it's more than 20 percent), the share of these enormous loans in total mortgage lending is already much higher than it was in 2007, before the previous bubble burst and the economy crashed.
The BOE has new macroprudential tools, but it used them this week to make an empty gesture. To see how empty, consider how delighted homebuilders were. Perhaps the central bank is afraid of the political consequences of using the tools more purposefully. To be fair, this fear is not without reason: Such tools would require them to intervene in the economy in ways that have heretofore been the province of politicians.
For now, though, these worries are premature. Aside from exceptions such as Canada, Norway and Sweden, central banks and other regulators typically lack even the means to make empty gestures.
Few deny the need for macroprudential policy. If speeches and conferences on the topic were a measure of progress, there'd be no cause for concern. Sadly, they aren't. Governments should develop a sense of urgency before it's too late.
--Editors: Clive Crook, Michael Newman.
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