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| Theoretical and Empirical Foundations of the Two-Pillar Framework |
| MA Yong
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| School of Finance/China Financial Policy Research Center, Renmin University of China |
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Abstract As a collective reflection on and policy response to the 2008 international financial crisis, policy makers around the world have formally adopted macro-prudential policy with the objective of developing a new type of policy tool that complements traditional monetary policy while directly reducing financial risks and promoting financial stability. The introduction of macro-prudential policy to central banks' policy frameworks as a new tool for macro financial adjustment has gradually shifted the traditional “one-pillar” adjustment framework based solely on monetary policy to a “two-pillar” adjustment framework underpinned by both monetary and macro-prudential policies.
Based on the essential logic of basic facts, basic theories, and basic practices, this study comprehensively explains the necessity, theoretical rationale, and practical feasibility of the two-pillar adjustment from three major perspectives, and further clarifies its actual foundation, practical implementation, and future improvements in China. The findings show that the two-pillar adjustment framework has both real world and theoretical foundations. First, financial stability has a notable impact on macroeconomic stability, but traditional monetary policies are unable to effectively achieve financial stability. According to “Dingbergen's Law” and the principle of policy comparative advantage, it is necessary to construct a new “policy pillar” (i.e., macro-prudential policy) to achieve the objective of financial stability. Second, given the deep integration and mutual influence between financial policy and the real economy, the traditional monetary policy pillar and the new macro-prudential policy pillar should be thoroughly coordinated and combined within a unified framework to improve the effectiveness and efficiency of policy implementation and to avoid policy conflicts and frictions. In addition, because the dynamics of the real economic and financial cycles are complex, the policy tools under the two-pillar adjustment framework (including both the monetary policy tools and the macro-prudential policy tools) should be adequate and complete enough to improve the accuracy, pertinence, and flexibility of policy implementation.
Drawing on the current two-pillar adjustment practices in major countries around the world, we focus on the three core issues of policy objective, policy tools, and policy coordination and consider how to form stable and reliable policy rules and a mature operational framework. First, to address the policy objective issue, we ask the following question: if the final goal of macro-prudential policy is financial stability, what specific target objectives should be used？ Without clear targets, the randomness of policy operations will increase, leading to instability in policy making and practices, resulting in less effective policy implementation. A literature review suggests that monitoring and judging activities could be improved by the construction of structural indices, as financial stability is affected by both aggregate and structural imbalances. Second, previous studies have shown that different macro-prudential policy tools influence financial stability through different paths and transmission mechanisms. Furthermore, under different structural imbalances, different tools have comparative advantages, so policy makers should consider constructing an “objective oriented” policy tool guide that reflects accumulated experience and further strengthens the pertinence, reliability, and effectiveness of the policy tools chosen for specific objectives and conditions. Third, one of the core aims in perfecting the two-pillar adjustment framework is to improve the coordination between monetary policy and macro-prudential policy. The rules and institutions must effectively deal with deviations and conflicts between the two basic goals of price (economic) stability and financial stability. They can also use the flexible configuration of multi tools to address long-term and global goals, thus improving the pertinence, flexibility, and effectiveness of policy implementation.
Finally, in the long run, the “two-pillar” adjustment framework should maintain a certain degree of openness and compatibility during the process of development, so that it can gradually achieve more unified and system-based coordination with a broad range of economic and financial policies.
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Received: 09 September 2019
Published: 13 January 2020
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