Bank’s policy proposals have serious flaws
The Bank for International Settlements has accused the world’s main central banks of incompetence
I admire the Bank for International Settlements. It takes courage to accuse its owners – the world’s main central banks – of incompetence. Yet this is what it has done, most recently in its annual report. It would be easy to dismiss this as the rantings of a prophet of doom. That would be a mistake. Whether or not one agrees with its pre-1930s view of macroeconomic policy, the BIS raises big questions. Contrariness adds value.
One can divide the BIS analysis into three parts: what caused the crisis; where we are now on the way out of it; and what we should do.
Credit boomOn the first, the perspective is that of the “financial cycle”. This analysis goes back to the work of Swedish economist Knut Wicksell at the turn of the 20th century. The core idea is that if the rate of interest is too low, a boom driven by expanding credit and rising asset prices may ensue.
One crucial (and correct) implication is that credit and money are endogenous: they are created by the economy. When the financial cycle turns from boom to bust, crises erupt. Then follow the “balance sheet recessions” described by Richard Koo of the Nomura Research Institute: painful deleveraging and extended periods of feeble growth.
Such cycles, says the BIS, “tend to play out over 15 to 20 years on average”. To give credit where it is due, the BIS gave such warnings well before the crisis hit high-income countries from 2007.
On the second, the BIS notes growth has picked up in the past year, with advanced economies gaining momentum, while emerging economies lose it. Recovery has been slow and weak in crisis-hit countries. Global growth is not far from rates seen in the 2000s, but the shortfall in the path of gross domestic product persists. Meanwhile, overall indebtedness continues to rise. Crises, we are reminded, cast a long shadow.
Furthermore, the policies of central banks are exerting extraordinary influence on financial markets, generating a “search for yield”, a disappearance of pricing for risk and a collapse in market volatility. This is true even though balance sheets remain so stretched. Meanwhile, credit excesses have emerged in a number of emerging economies.
The BIS is particularly concerned about new sources of vulnerability in the latter, including foreign borrowing by non-financial corporates. Overall, concludes the BIS wryly, “It is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments.”
It is on the third point – what is to be done – the BIS turns into a prophet from the Old Testament: it demands austerity now. In countries that have experienced a financial crisis, it recommends balance sheet repair and structural reform: deregulation, improved labour flexibility and “trimming public sector bloat”. It demands fiscal retrenchment. But unlike, say, George Osborne, the UK chancellor of the exchequer, the BIS wants to see monetary stimulus withdrawn, too, emphasising the risks of “exiting too late and too gradually”. It plays down both risks and costs of deflation, despite the huge overhang of debt that it also stresses. Even Jens Weidmann, the Bundesbank president, does not do that.