The world economy has entered a vicious circle in which the efforts of governments, businesses, financial sector and ordinary people to get rid of debt worsen the outlook of each other, warns the Bank for International Settlements (BIS), the oldest financial institution which ensures cooperation between central banks around the world. Five years after the financial crisis engulfed the global economy, the world doesn’t seem closer to finding a sustainable business model and regulatory structures have to address bank problems forcing them to accept losses, to eliminate these losses from balance sheets and to strengthen capital to finance economic growth, it said in a BIS report quoted by Financial Times.
“Revitalization of banks and financial industry will end the destructive interaction with other sectors and will enable the next steps, meaning fiscal consolidation and debt reduction in non-financial private sector. Only then can we return to a balanced growth path,” said BIS chief economist Stephen Cecchetti in the BIS annual report on 2012. According to the document, the budgets of most advanced economies, excluding interest payments, “would require 20 years of consecutive growth higher than 2% of GDP – starting now – to bring the debt/GDP at a pre-crisis level”.
Monetary policy has to date been the main instrument against the crisis, but this approach creates a risk that economies become dependent on very low interest. “Possibilities of action of central banks have very clear limits. They can’t repair balance sheets. They can increase productivity and can’t place policies on a sustainable path,” said Cecchetti. He added that each year the leaders fail to take measures for fiscal consolidation will extend recovery period.
Mostly developed economies are exposed to risks, especially those in Europe, but also emerging economies face risks that are becoming higher, especially those that have grown rapidly through exports to more developed neighbors.
“Countries like Russia and India could have considerable problems if their trading partners will record a downturn, as is predictable, in the period 2011-2015”, notes the report.
Jaime Caruana, General Manager of BIS and former Governor of National Bank of Spain warns that recent aggressiveness of central banks could create “unrealistic expectations” about their power to “solve the fundamental problems” and expanding activities of central banks would mean risks , according to notes prepared for the BIS annual meeting cited by the Wall Street Journal. “Monetary policy provides time for other policies to correct the fundamental problems of balance sheets. But even this transitional role has limits and risks. In current circumstances, the benefits of a continuously quantitative easing will not come without costs,” said Caruana.
The risks coming from central banks
Caruana identified three major risks related to central bank actions. The first risk comes from the fact that “prolonged monetary stimulation makes fiscal and structural adjustments seem less urgent”, allowing banks and governments to defer some painful, but necessary changes. The second risk comes from low interest loans, which could cause investors and financial institutions to take greater risks in search of better efficiency. Last is that central banks might have difficulties in “calibrating and implementing monetary contraction, which will inevitably be necessary”, and could produce a new credit bubble or inflation explosion.
“Fiscal adjustment, repairing bank balance sheets and other reforms can not be delayed in the hope of better times,” Caruana said, adding that there is a need to act on other fronts, not only at central bank levels, otherwise confidence in the economy will continue to decrease, which will increase the risks to macroeconomic and financial stability.
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