Understanding macroprudential divergence: growth models, housing systems and the issue of financial stability

The implementation of the macroprudential policy programme in individual countries has been remarkably uneven. A closer look at the importance of national growth models and housing systems for issues of financial stability helps us understand why.

Following the global financial crisis (GFC), a consensus among policy makers quickly emerged about the fact that regulators should pay much more attention to dynamics within the financial system as a whole, rather than just trying to assure the safety of individual institutions. It is this “new” systemic view that has become known as “macroprudential policy”.

A lot of excellent scholarship has looked at how a certain type of politics of expertise has shaped this macroprudential approach at a transnational level. It has been shown for instance how macroprudential policy ideas travelled particularly fast due to the distinct dynamics within central banking networks, while at the same time the cautiousness of agents within these networks fuelled incrementalism at the expense of radical policy change.  Overall, we thus already know a lot about the drivers of macroprudential policy at a “macro” level.

Once we zoom in on particular countries, however, we also see considerable divergence both in terms of the level of macroprudential activism, as well as the specific institutional and legal shape that macroprudential regimes take, and so far we know very little about what drives this divergence. In a recent paper in Comparative European Politics, I set out to investigate this phenomenon more closely, by looking at the divergent macroprudential practices in Germany and the UK as they relate to housing finance. The paper finds that the drivers of divergence are quite different from those dynamics that have been singled out to explain developments at the transnational level.

Divergent macroprudential trajectories

Housing related policies are among the most common and most talked about macroprudential interventions. This is hardly surprising, given the fact that there now seems to be almost a complete consensus among academics that housing busts are the most important factor in turning what could have been some minor financial turmoil or economic downturn into a much worse recession. By intervening countercyclically (i.e. tightening policy in good times and relaxing it when things turn bad) in these markets, macroprudential proponents hope that they can both prevent the worst excesses, and soften any potential downturns. On these goals nearly everyone can agree. Once it comes to turning these insights into a national policy regime, however, differences start to emerge.

While Britain in many ways was a pioneer when it came to macroprudential policies and experimented with housing related interventions early on, German policy makers were much more reluctant to establish and activate the same macroprudential instruments in this sector even in the face of international criticism. One of the reasons that my research found with regards to these differences, is that central banks in the two countries constructed the goals of macroprudential policy in somewhat different ways.

In particular, German authorities where mainly concerned with the overall health of the banking system, and thus with the adverse impact that housing sector dynamics could have on their banks. British central bankers, to be sure, were also interested in these issues. However, they were even more concerned about the negative impact that housing sector dynamics could have on the consumption behaviour of households, and what this might mean for aggregate demand.  This in turn, however, raises the question of why this divergence in goals occurred. A brief look at the very different types of financial system as well as the growth models within these two countries can help shed light on this.

Differences in context

A lot of ink has been spilled on the specificities of the UK brand of Anglo-Saxon financialised capitalism and the type of “privatised Keynesianism” on which its growth model is based. In a nutshell, it can be shown that there is a much closer link in the UK between periods of household borrowing and deleveraging, and overall macroeconomic outcomes than there is in Germany. There are two components to this. First, successive waves of liberalisation of financial markets have left households in the UK nearly twice as indebted as their German counterparts. Second, overall the British growth model is much more reliant on continued domestic demand to stabilise aggregate output. To this we can add a host of other factors such as the barriers to equity withdrawal financing of consumption in Germany, or the dominance of small savings and cooperative banks in the provision of housing finance, and it becomes clear why the stabilisation of aggregate demand was a much bigger concern in the UK, and contributed to a somewhat different construction of the goals of macroprudential interventions there.

All of this is not to say that the German system doesn’t suffer from its own problems. The same small and medium sized banks that have helped stabilise housing finance, in turn display particular vulnerabilities towards certain interest rate developments that could eventually prove to be their Achilles heel.  For now, however, it seems that in many respects the macroprudential ideas around removing procyclicality in housing markets seem to be particularly significant in the UK context, where housing boom and busts are a common occurrence, and where aggregate demand is particularly vulnerable to changes in credit provision. As such, neither the fact that the Bank of England constructed the intermediate goals of their housing related macroprudential policies in a somewhat different way, nor the fact that it pursued a more activist approach, should come as a surprise.