Central banks can’t expand loose monetary policy without exacerbating risks to world economies, the Bank for International Settlements said.
“Central banks cannot do ‘whatever it takes’ to return still-sluggish economies to strong and sustainable growth,” Stephen Cecchetti, economic adviser and head of the monetary and economic department at the BIS in Basel, Switzerland, told reporters on a conference call. “Central banks cannot do more without compounding the risks they have already created.”
By putting policy rates close to zero and expanding balance sheets central banks have given borrowers and banks time to repair their finances, though progress has been “uneven” across countries, he said. Monetary institutions must refocus on their traditional role of encouraging adjustment, while authorities must hasten reform to shore up creditworthiness.
“It is others that need to act, speeding up the hard but essential reform and repair work to unlock productivity and employment growth,” Cecchetti said. “Each country needs to tailor the reform agenda to maximize its chances of success without endangering the ongoing economic recovery.”
Cecchetti spoke on a briefing to mark the release yesterday of the BIS’s annual report, which said that low interest rates are creating “international spillovers” that direct capital flows to fast-growing economies that pushes up currencies. Delivering more stimulus is becoming “increasingly perilous” and puts monetary policy officials in a “delicate position,” it said.
Restoring growth requires reforms to encourage capital to shift from industries that became too big during the boom to sectors that have prospects of being more productive, according to the report. Structural rigidities in the form of price controls, exemptions from competition law for public enterprises, and similar rules will slow growth and should be liberalized, the BIS said.
Progress in fiscal reform has been “uneven,” according to the report, with the biggest improvements coming from countries with restricted financial market access, such as Greece, and lower improvement in nations where interest rates are below historical averages, such as the U.K.
Creating fiscal sustainability isn’t a matter just of stabilizing current debt levels, as they expose borrowers to a risk investors will demand higher risk premia to offset the threat of default, and they also reduce scope for counter-cyclical policy, the BIS said, adding that future spending on healthcare and pensions will also create a drag on adjustment.
The BIS said that globally, the signs of economic recovery are “uneven,” and that progress that has been made may be jeopardized by deteriorating sentiment.
“In the presence of weak growth and insufficient structural reforms, there remain risks of a sudden deterioration in market sentiment,” the report said. “The need for balance sheet repair continues to slow growth and render many advanced economies vulnerable.”
The risks of continued loose policy also raise issues concerning central bank exit from extraordinary stimulus, according to the report.
There are “open questions” on how markets will react, and there are limits on how far counterparties can hedge against higher rates. In addition, a sharp rise in rates could also generate stress in the financial system, the BIS said.
The BIS report went to press June 13-14, before Federal Reserve Chairman Ben S. Bernanke’s comments on June 19 that the Fed will probably taper its bond buying next year sparked volatility in global bond and equity markets.
“Disruptive market dynamics could even materialise as soon as central banks signal that an exit is imminent,” the BIS said. “The risk that exit will be delayed to avoid such disruptions is likely to rise over time, as the situation becomes more entrenched.”