CENTRAL BANKS WALK POLICY TIGHTROPE / THE WALL STREET JOURNAL

Heard on the Street

Central Banks Walk Policy Tightrope

Efforts to Safeguard Economies Risk Causing New Distortions

By Richard Barley

Feb. 17, 2014 7:16 a.m. ET


It's a fine line to walk. Central banks in many developed economies are holding rates near zero to protect fragile economies. But they are also rightly wary about the potential for those low rates to stoke new distortions, such as housing bubbles.

The apparent answer to this challenge is so-called macroprudential policy, seen as a targeted way to intervene to rein in imbalances such as excessive lending via regulatory measures. The Bank of England has made clear that this, rather than the blunt tool of a rate increase, is the preferred option in dealing with excesses in a revitalized housing market; the Swiss National Bank is already trying out tweaking capital requirements to manage the risks in its real-estate market.

But will it work? The BOE points to examples such as changes to risk weightings for commercial real estate in India in 2005-2006, or to car loans in Brazil in 2010, where there was a large reduction in lending. That suggests that very targeted measures can work.

But while macroprudential policy might slow lending growth, it may not have the same clout as an interest-rate hike in changing borrowers' behavior.

In Sweden, the Financial Supervisory Authority noted in December that despite higher capital requirements for banks, lending has continued to grow, while the impact on lending rates had been small; Swedish household debt stands at above 170% of disposable income. The Riksbank says knowledge about the effectiveness of macroprudential policy is still limited.

In Switzerland, the SNB has had to launch a second round of increases to the capital required to be held against mortgages. So far, the effect of macroprudential policy there appears limited. UBS's Swiss Real Estate Bubble Index continued to climb into the "risk" category in the fourth quarter; house prices are growing faster than income and mortgage debt is now around 110% of gross domestic product. Swiss fixed-interest mortgage rates have risen only 0.08-0.09 percentage point, notes Nomura. Talks are now under way on further measures that may include tightening lending criteria.

The risk is that consumers may only respond to something that puts clear limits on what they can borrow, such as caps on loan-to-value ratios, or debt-service ratios. These would undoubtedly be powerful, but could also be controversial. The BOE has said it thinks there needs to be a broad public debate about LTV restrictions for them to be acceptable.

The key issue here may well be one of signaling. An announcement that a central bank is requiring banks to raise their countercyclical capital buffers, or that it is changing sectoral capital requirements, is clearly going to be more difficult to explain than a rise in a country's interest rate. And it will take a lot to drown out the signal that rates at historical lows send to housing markets and home buyers. The tightrope central banks are trying to walk may be a perilous one.


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