Making The Most Of Borrowed Time

Bank Of International Settlements ^ | 6-23-2013 | Jaime Caruana

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Making The Most Of Borrowed Time (Central Banks Have Had Enough?)

Jaime Caruana, General Manager of the BIS on the occasion of the Bank’s Annual General Meeting in Basel on 23 June 2013

Good afternoon, ladies and gentlemen.

Since the beginning of the financial crisis almost six years ago, central banks and fiscal authorities have supported the global economy with unprecedented measures. Policy rates have been kept near zero in the largest advanced economies. Central bank balance sheets have doubled from $10 trillion to more than $20 trillion. And fiscal authorities almost everywhere have been piling up debt, which has risen by $23 trillion since 2007. In emerging market economies, public debt has grown more slowly than GDP; but in advanced economies, it has grown much faster, so that it now exceeds one year’s GDP. These trends can be seen in Graph 1.

(click to the site to see the graphs)

Without these forceful and determined policy responses, the global financial system could easily have collapsed, bringing the world economy down with it. But the subsequent global recovery has remained halting, fragile and uneven. In the United States, the expansion continues, albeit at a moderate pace. In major emerging market economies, growth is losing momentum. Most of Europe has fallen back into recession. At the same time, the general downward trend in productivity growth has not been receiving enough attention from policymakers.

As the risks mounted around mid-2012, central banks rode to the rescue yet again. The ECB addressed market fears with the promise that it would do “whatever it takes” within its mandate to save the euro. It followed up with a conditional programme to buy sovereign debt of troubled euro area countries. The Federal Reserve, the Bank of England and the Bank of Japan likewise pushed forward with additional expansionary measures.

And while large advanced economies were expanding their unconventional policies, central banks in many emerging market economies lowered their target policy rates, in some cases reducing them to their 2009 levels.
As global financing conditions eased further, private credit continued to grow at a rapid pace in some countries, lending standards weakened, equity prices reached record highs worldwide, long-term yields hit record lows and credit spreads compressed. Even highly leveraged firms could borrow at long-term rates far below the rates they had to pay before the crisis.

But easy financial conditions can do only so much to revitalise long-term growth when balance sheets are impaired and resources are misallocated on a large scale. In many advanced economies, household debt remains very high, as does non-financial corporate debt.
With households and firms focused on reducing their debt, a low price for new credit is not terribly relevant for spending. Indeed, many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity. It does not matter how attractive the authorities make it to lend and borrow – households and firms focused on balance sheet repair will not add to their debt, nor should they.

And, most of all, more stimulus cannot revive productivity growth or remove the impediments that block a worker from shifting into a promising sector. Debt-financed growth masked the downward trend in labour productivity and the large-scale distortion of resource allocation in many economies. Adding more debt will not strengthen the financial sector nor will it reallocate resources needed to return economies to the real growth that authorities and the public both want and expect.

Central banks have borrowed the time that the private and public sectors need for adjustment, but they cannot substitute for it. Moreover, such borrowing has costs. As the stimulus is sustained, it magnifies the challenges of normalising monetary policy; it increases financial stability risks; and it worsens the misallocation of capital.

Finally, prolonging the period of very low interest rates further exposes open economies to spillovers that are now widely recognised. The challenges are particularly severe for the emerging market economies and smaller advanced economies where credit and property prices have been rapidly growing. The risks from such a domestic credit boom at a late stage of the economic cycle are hard enough to manage. Strong capital inflows exacerbate such risks and challenges for market participants and authorities; and they expose economies to large sudden reversals if markets expect an exit from unconventional policies, as volatility during the past few weeks seems to indicate.

In short, the balance of costs and benefits entailed by continued monetary easing has been deteriorating. Borrowed time should be used to restore the foundations of solid long-term growth. This includes ending the dependence on debt; improving economic flexibility to strengthen productivity growth; completing regulatory reform; and recognising the limits of what central banks can and should do.

Ending the dependence on debt Extending monetary stimulus is taking the pressure off those who need to act. Ultra-low interest rates encourage the build-up of even more debt. In fact, despite some household....

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final solution to follow...

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