A macro‐prudential perspective of financial regulation

Publication Date26 July 2011
Date26 July 2011
AuthorTristan Nguyen
SubjectAccounting & finance
A macro-prudential perspective
of financial regulation
Tristan Nguyen
Department of Economics, WHL Graduate School of Business and Economics,
Lahr, Germany
Purpose – In the recent financial crisis, many observers have assigned monetary policy a central role
in the crisis. Specifically, they claim that excessively easy monetary policy by the Federal Reserve in
the first half of the decade helped to cause a bubble in housing prices in the USA. The purpose of this
paper is to analyze the role of monetary policy within the regulatory frameworks of financial markets.
Design/methodology/approach The authors show within a macroeconomic framework a
possible trade-off between price stability and financial stability by differentiating between a
technology-driven bubble and an animal spirit bubble. In their conclusion: if there is a trade-off
between price stability and financial stability, the central bank will have to make a choice between the
two objectives. In that case, the question arises of which of the two objectives should take precedence:
price stability or financial stability?
Findings – From this analysis, the authors conclude that a central bank which uses a lexicographic
ordering favoring price stability over other objectives is likely to fuel the boom inadvertently (in the
case of a technology-driven bubble) or will decide to do nothing (in the case of an animal spirit bubble)
allowing a process of excessive credit creation. The latter seems to be what happened between 2003
and 2008.
Practical implications – If one wants to reduce the likelihood of future major financial busts,
it must be accepted that the central banks (especially the Fed and the ECB) cannot only be responsible
for price stability. Maintaining financial stability by preventing excesses in financial markets should
be an equally important objective.
Originality/value – The paper gives a new perspective on the role of monetary policy within the
regulatory framework. With this macroeconomic framework, the authors are able to show possible
trade-offs between price stability and financial stability. The micro- and macro-prudential approach of
this paper is a useful contribution to the discussion about regulatory reforms of financial markets.
Keywords Regulation,Central banks, Monetarypolicy, Macro-prudentialregulation, Financial stability
Paper type Research paper
1. Introduction
The recent financial crisis revealed that in a globalized world with large asymmetries of
information and complex financial innovations the existing regulatory frameworks for
the financial sector do not work properly. Public opinion has charged several agencies as
the cause of this crisis. At the top of the list of culprits is the private financial system
itself. Financial managers and bankers were among the first and most heavily criticized
agents blamed for the outbreak of the financial crisis. For example, President Barack
Obama labeled private bankers as “fat cats” on Wall Street who are “greedy-for-money”.
Many bankers are criticized that they exclusively followed personal short-term profit
interests without regard to risk or common sense. It is worthless to say that many of the
financial managers and bankers deserve the “greedy” label. However, one should also
take into account that they acted in an “individually rational” way – performing
their specific functions – within the structural frameworks set by governm ents
The current issue and full text archive of this journal is available at
Journal of Financial Regulation and
Vol. 19 No. 3, 2011
pp. 289-297
qEmerald Group Publishing Limited
DOI 10.1108/13581981111147900

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