Abstract

Financial Innovation: Macro-Economic and Macro-Prudential Consequences

The past two or three decades have witnessed accelerating change in financial markets, driven by the interaction of deregulation and innovation. The most recent series of innovations have been in the market for derivative financial instruments. These developments raise questions for monetary authorities of both a macroprudential and macro-economic character. Macro-prudential or systemic risk is the risk that an individual disturbance (whether at a firm, in a market segment or in a settlement system) might cause more widespread difficulties. The avoidance of systemic risk requires strengthened risk management practices in individual firms, as well as actions to improve the resilience of markets to outside disturbances. Macro-economic issues arise from the possibility that the increased ease of position- taking resulting from derivatives will complicate the task of formulating and implementing monetary policy. Derivatives could influence the behaviour of individual economic agents or market dynamics. In addition, they could have implications for the reliability of economic indicators and instruments. Relatively little is known about the precise channels through which derivatives can affect the efficacy of monetary policy. Even if there is no presumption that they hamper its implementation, additional research is desirable.