Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Use Macroprudential Policy to Cool Housing Markets
Transcript
- Lucas: So the Reserve Bank of New Zealand did something interesting back in 2021. They tightened loan to value ratio restrictions on mortgage lending — basically telling banks they couldn't lend more than a certain percentage of a home's value — while the official cash rate was still at 0.25 percent. They were trying to cool a housing market that had gone up about 30 percent in two years, without raising rates for the whole economy. Luna: Right — because raising the cash rate would have hit every borrower and business, not just the ones piling into housing. So they used a scalpel instead of a sledgehammer. Lucas: Exactly. And that's the essence of what we call macroprudential policy. It's a set of regulatory tools aimed at the stability of the financial system as a whole — not at inflation or employment, which is what traditional monetary policy targets. The goal is to prevent bubbles building up in specific sectors, like housing, without having to slow the entire economy. Luna: So how does it differ from microprudential regulation — the kind that looks at individual bank safety? Lucas: Good question. Microprudential regulation — things like capital requirements for each bank — is about making sure a single institution doesn't go bust. Macroprudential looks at the system as a whole. A classic example: if every bank makes the same risky bet on housing, individually they might look fine, but collectively they're all exposed to the same shock. Macroprudential tools try to limit that common exposure. Luna: And New Zealand is a good case because they had a clear problem — house prices were soaring, household debt was piling up — and they had a specific tool ready to go. Lucas: Yeah, they had been using loan to value ratio restrictions since 2013, but in 2021 they tightened them further. For owner-occupiers, they limited new loans to no more than 80 percent of the property's value — so a 20 percent deposit. For investors, it was even tighter: a 40 percent deposit. And they added debt to income caps later that year, limiting how much a borrower could take relative to their income. Luna: And it worked — at least in the short run. House price growth slowed down and even reversed a bit in 2022. Lucas: It did. But there's a broader point here. Macroprudential tools are powerful, but they have limits. They can be blunt — a loan to value ratio cap might shut out first-home buyers who have a good income but not a big deposit. And they can push lending into unregulated parts of the financial system, like non-bank lenders, where the rules don't apply. That's called regulatory arbitrage. Luna: So you end up with the risk migrating rather than disappearing? Lucas: Exactly. That's one of the big criticisms. Another is that macroprudential tools are hard to calibrate. How tight should the cap be? If you set it too loose, it doesn't slow the market. Too tight, you crash prices and hurt households who've already bought. Central banks have to feel their way through, adjusting every few months. Luna: And then there's the interaction with regular monetary policy. If the central bank is keeping rates low to support the economy, but macroprudential tools are tight, you're sending mixed signals. Lucas: That's a real tension. In New Zealand, the Reserve Bank was simultaneously cutting rates during the pandemic — that's expansionary — and tightening loan to value ratios — that's contractionary for housing. It's a delicate balancing act. But the theory is sound: use the right tool for the right job. Monetary policy for aggregate demand, macroprudential policy for financial stability. Luna: Honestly, if today's episode made the macroprudential toolkit click for you — knowing when a central bank might use loan to value caps versus raising rates — that's the kind of thing listener support keeps ad-free. If it was worth a coffee to you, that's the link: buy me a coffee dot com slash fexingo. Lucas: Yeah, and it genuinely helps us keep digging into these specific tools. So — back to the toolkit. One of the most widely used macroprudential tools internationally is the countercyclical capital buffer, or CCyB. Luna: That's the one where banks have to hold more capital when credit is growing fast, and they can release it when the economy turns down. Lucas: Exactly. It's designed to build up a buffer in good times so banks can absorb losses in bad times without cutting lending. The Basel Committee on Banking Supervision sets the framework, but each country can set its own rate. In the UK, the Bank of England has the Financial Policy Committee that sets the CCyB rate. They raised it to 2 percent in 2022 as credit growth picked up, then cut it to zero at the start of the pandemic to support lending. Luna: So it's countercyclical by design — lean against the wind. Lucas: Precisely. Another tool is the debt service to income ratio cap, which limits a borrower's monthly debt payments as a share of income. That's been used in Ireland, Sweden, and Norway. In 2021, Sweden's financial regulator capped new mortgages at 4.5 times income — meaning your mortgage can't be more than 4.5 times your gross annual income. That directly limits how much households can borrow, regardless of interest rates. Luna: And there's also the loan to value cap we already mentioned. But I think the key insight is that all these tools target the borrower or the lender at the transaction level, not the overall money supply. Lucas: Right. That's what makes them 'macroprudential' — they focus on the system's vulnerabilities. The idea is to identify where risk is concentrated — say, in highly leveraged household mortgages — and then impose rules that reduce that concentration. The Financial Stability Board, the IMF, and the Bank for International Settlements all advocate for this approach. Luna: But they also warn that macroprudential policy alone can't prevent all crises. If the underlying problem is a credit boom fueled by low global interest rates, these tools might just slow it, not stop it. Lucas: That's fair. And there's evidence from countries like South Korea and Canada that macroprudential measures can be circumvented. In Canada, when regulators tightened loan to value ratios for insured mortgages, banks started offering uninsured mortgages with higher loan to value ratios through subsidiaries. So the risk moved, but it didn't disappear. Luna: And that's why most central banks now use a combination of tools — a whole macroprudential 'dashboard' — and they adjust them over time based on market conditions. Lucas: Exactly. In the European Union, the European Systemic Risk Board coordinates macroprudential policies across member states. They issue warnings and recommendations. For example, in 2019 they recommended that countries impose a borrower-based measure like a loan to income cap on new mortgages. Several countries, including the Netherlands and Ireland, already had such measures in place. Luna: So the framework is really about making the financial system more resilient — not necessarily about preventing the occasional correction, but about ensuring that when it happens, it doesn't bring down the banks. Lucas: Bingo. That's the fundamental goal. The 2008 global financial crisis showed that microprudential regulation — focusing on individual banks — wasn't enough. Banks that looked healthy on their own were collectively vulnerable because they all held similar assets: US mortgage-backed securities. Macroprudential policy was the response to that blind spot. Luna: And since then, most major central banks have set up dedicated financial stability committees — like the Fed's Financial Stability Oversight Council, or the Bank of England's Financial Policy Committee. Lucas: Right. And those committees meet regularly and publish financial stability reports. They track indicators like household debt to income ratios, commercial real estate prices, and bank exposure to certain sectors. When those indicators flash red, they can activate tools. Luna: So if you're a listener wondering whether your own central bank might tighten mortgage rules soon, you can look at those reports — they're usually public — and see what the committee is worried about. Lucas: Absolutely. For example, the Bank of Canada's Financial Stability Report from May 2026 highlighted elevated household debt levels and a hot housing market in Toronto and Vancouver. They didn't immediately tighten, but they said they were monitoring. That's a classic macroprudential signal — a warning shot before the policy change. Luna: And in a way, that's also a form of communication — like forward guidance, but for financial stability. Lucas: It is. And it's a good example of how macroprudential policy dovetails with monetary policy. They're separate tools, but they both influence financial conditions. The art for central bankers is coordinating them without confusing markets. Luna: Let's wrap with a practical takeaway. If you're an investor or a homeowner, what should you watch for? Lucas: I'd say three things. One, pay attention to your central bank's financial stability reports — they'll flag the risks. Two, watch for announcements about loan to value or debt to income caps, especially in overheated housing markets. Three, remember that macroprudential tools can take months to bite, so if they're announced, the effect on prices and lending isn't instant. Luna: And that's the kind of concrete insight that makes this show worth a listen. For more, you know where to find the full archive. Lucas: Next time, we'll look at how central banks use emergency lending facilities during a crisis — the lender of last resort function in action.