ECB: Macroprudential Policy Limits Can Increase Need for Aggressive Monetary Accommodation

17 November 2021

By David Barwick – FRANKFURT (Econostream) – Limitations in the current macroprudential policy framework can make forceful monetary policy accommodation more necessary, the European Central Bank said on Wednesday.

In a contribution to the Financial Stability Review that looked at the role of financial stability in the ECB’s new monetary policy strategy, the ECB said that how monetary policy and financial stability interact would be assessed ‘at regular intervals’ and ‘considered at monetary policy meetings’.

‘These assessments will provide a more systematic evaluation of the longer-term build-up of financial vulnerabilities and their implications for the tail risks to output and inflation’, the ECB said. ‘In addition, they will gauge the extent to which macroprudential policies can mitigate possible financial stability risks that are relevant from a monetary policy perspective.’

Macroprudential tools, the ECB said, ‘are the first line of defence against the build-up of systemic risk’, a view it said was empirically corroborated. The current framework, however, neither sufficiently covers non-bank financial intermediaries nor permits macroprudential policies adequate ability to influence bank lending countercyclically, the ECB said.

These limitations ‘may increase the need for aggressive monetary policy accommodation in the face of adverse developments’, it said.

The ECB noted that ‘lower interest rates create incentives to engage in more risk-taking which could become excessive and lead to the build-up of systemic risk.’ Monetary policy can be designed to limit financial stability risks, it said, citing the ECB’s tiered system for excess reserve remuneration as well as targeted longer-term refinancing operations (TLTROs), whose exclusion of housing loans from the lending target helps avoid housing market bubbles.

‘However, potential financial stability side effects cannot be completely ruled out’, the ECB said, noting a range of effects from low interest rates, some positive and others negative. ‘While for now these effects have largely offset each other, the adverse effects of low interest rates could worsen over time’, the ECB said.