Central Banks Face Limits of Power as Crisis Persists

ECB President Mario Draghi
European Central Bank President Mario Draghi has indicated that the ECB is close to exhausting its tools after cutting its benchmark rate to a record low and flooding the banking system with cash. Photographer: Hannelore Foerster/Bloomberg

Central banks in developed nations are confronting the limits of their ability to aid economic recovery as government efforts to strengthen their finances fall short, the Bank for International Settlements said.

“Central banks are being cornered into prolonging monetary stimulus as governments drag their feet and adjustment is delayed,” the Basel, Switzerland-based BIS said in its annual report, published yesterday. “Both conventionally and unconventionally accommodative monetary policies are palliatives and have their limits.”

While central banks’ actions were key to limiting damage from the collapse of Lehman Brothers Holdings Inc., interest rates are now “as low as they can go” and debt purchases have swollen central bank balance sheets, the BIS said. European Central Bank President Mario Draghi has indicated that the ECB is close to exhausting its tools after cutting its benchmark rate to a record low and flooding the banking system with cash.

“In the middle of all this we find the overburdened central banks, pushed to use what power they have to contain the damage,” Stephen Cecchetti, BIS economic adviser, said on a conference call. “There are very clear limits to what central banks can do. It’s critical for the health of the global economy to break the vicious cycles and reduce the pressure on central banks.”

Europe Impasse

In the 17-nation euro area, leaders are at an impasse on how to solve the debt turmoil as they prepare to meet for a summit in Brussels on June 28, which will be their 19th since the crisis erupted.

Billionaire investor George Soros called yesterday on governments to start a fund to buy Italian and Spanish bonds, warning in a Bloomberg Television interview that a failure to produce drastic measures could spell the demise of the currency. German Finance Minister Wolfgang Schaeuble said on ZDF television that joint debt sales in the euro area “don’t make sense” as long as budgets are set by national governments.

The BIS said central bank policy “buys time” in the short term for banks and governments to tackle debt overhangs. Extraordinary measures have reduced incentives for politicians and other borrowers to repair balance sheets, and created the illusion that central banks can do much more to stoke growth and redress imbalances, it said.

The organization was formed in 1930 and acts as a central bank for the world’s monetary authorities.

Policy Loosening

European stocks declined today, with the Stoxx Europe 600 Index dropping 0.9 percent as of 10:08 a.m. in London. The MSCI Asia Pacific Index fell 0.7 percent, while Standard & Poor’s 500 Index futures also slid 0.7 percent.

Central banks are continuing to act to try to bolster growth. The Federal Reserve expanded its Operation Twist program last week and will swap $267 billion in short-term securities with longer-term debt. The ECB has lent more than 1 trillion euros ($1.26 trillion) at its benchmark rate, and said this month it will continue to provide liquidity to solvent banks.

At the Bank of England, four of nine policy makers pushed for more bond purchases this month, including Governor Mervyn King, who said the case for more stimulus is “growing.” David Miles, who was also among the four, said in an interview published in the Financial Times today that the “right strategy has been super-expansionary monetary policy.”

King, Miles, along with Chief Economist Spencer Dale and policy maker Ben Broadbent are due to speak at a Parliament committee in London tomorrow starting at 10 a.m.

Indian Measures

In Asia today, India increased the amount of rupee-denominated debt overseas investors can own to arrest a slide in the currency, which sank to a record-low on June 22.

The ownership ceiling on government bonds was raised by $5 billion to $20 billion, Finance Minister Pranab Mukherjee said. The combined limit on sovereign and corporate debt was last increased to $60 billion from $50 billion in November. The move is part of a slew of measures unveiled by Mukherjee to shore up Asia’s worst-performing major currency this year. The rupee’s decline has intensified prices pressures in the economy.

In the U.S. today, an economic report will show new-home sales rose less than 1 percent to a 346,000 annual pace in May, according to the median forecast in a Bloomberg News survey. The Commerce Department will release the figures at 10 a.m. in Washington.

Balance Sheet Risks

The BIS said global central bank assets are at $18 trillion, about 30 percent of global gross domestic product, double the ratio a decade ago.

“As the benefits of extraordinary monetary easing shrink and become less certain, the risks of expanding central bank balance sheets are likely to grow,” Jaime Caruana, general manager of the BIS, said in a speech in Basel yesterday. “Such hazards may materialize in ways that are not completely clear today.”

Loose policy also poses risks for developing nations by fueling credit- and asset-price booms, complicating efforts to stabilize price gains, the BIS report said. In emerging economies, interest rates have been raised “only hesitantly” out of concerns about stoking further capital inflows.

“As a result, monetary policy in emerging-market economies may be systematically too loose,” the BIS said. “This creates risks of rising financial imbalances” similar to those in advanced economies before the crisis.

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