The Conceptual Foundations of Macroprudential Policy: A Roadmap

21 Pages Posted: 20 Apr 2016

See all articles by Augusto de la Torre

Augusto de la Torre

UDLA, Centro de Investigaciones Económicas; Columbia University, SIPA

Alain Ize

World Bank

Date Written: August 1, 2013

Abstract

This paper explores post-Lehman macroprudential regulation by interacting two types of market failures (principal-agent and collective action) with two cognition modes (unconstrained and constrained) in the context of aggregate risk. Four paradigms with orthogonal policy justifications are identified. In the first time consistency paradigm, regulation offsets the moral hazard implications of efficient but time inconsistent post-crisis bailouts. In the second dynamic alignment paradigm, it protects unsophisticated market participants by maintaining principal-agent incentives continuously aligned in the face of aggregate shocks. In the third collective action paradigm, regulation arises in response to the socially inefficient yet rational financial instability resulting from uninternalized externalities. The fourth collective cognition paradigm is grounded on the need to temper the mood swings that arise from bounded rationality or severe cognitive frictions in a rapidly changing, complex and uncertain world. These four rationales give rise to important tensions and trade-offs in the design of macroprudential policy.

Keywords: Labor Policies, Debt Markets, Banks & Banking Reform, Financial Intermediation, Emerging Markets

Suggested Citation

de la Torre, Augusto and Ize, Alain, The Conceptual Foundations of Macroprudential Policy: A Roadmap (August 1, 2013). World Bank Policy Research Working Paper No. 6576, Available at SSRN: https://ssrn.com/abstract=2311109

Augusto De la Torre (Contact Author)

UDLA, Centro de Investigaciones Económicas ( email )

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

Columbia University, SIPA ( email )

420 West 118th Street
New York, NY
United States

Alain Ize

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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