Global economic policy needs an urgent overhaul to cope with a world of persistently high debt and weak productivity and in which monetary policy is out of ammunition, the Bank for International Settlements believes.
The Swiss-based institution says that governments must focus more broadly on controlling inflation and should clearly establish central banks’ limits to shake off the trap of debt-fuelled growth.
Central banks also should look at unemployment and financial stability. Fiscal policy should be run with long-term financial stability in mind. That means acting in “both booms and busts, and not just occasionally when signs of unsustainable financial booms become evident”, Jaime Caruana, the BIS general manager, said.
He was speaking at the launch of the body’s annual report, in which the BIS warned that the world faced a “risky trinity” of high debt, low growth and dwindling firepower among the world’s big central banks.
Mr Caruana raised concerns that central banks were being pushed too far. “The wish-list has become quite long: restore full employment, ensure sustained growth, preserve price stability and deliver a foolproof financial system. This is a tall order and central banks alone cannot deliver on it,” he said.
“The extraordinary measures taken to stimulate the global economy have sometimes tested the boundaries of the institution. The line between monetary and fiscal measures has become increasingly blurred.”
Interest rates across the world have been cut so low that more than $7 trillion of government debt has a negative yield. At the same time, cheap money has caused the world’s total debt to continue expanding since the financial crisis, with signs of financial booms appearing in emerging markets, the BIS said.
Despite sub-zero rates and trillions of dollars of stimulus, central banks are struggling to lift inflation and growth. Markets are growing concerned that the firepower is mostly spent.
“Should this situation be stretched to the point of shaking public confidence in policymaking, the consequences for financial markets and the economy could be serious,” Claudio Borio, head of the BIS monetary and economic department, said.
To deal with what Mr Borio labelled the “risky trinity of productivity growth that is unusually low, global debt levels that are historically high and room for policy manoeuvre that is remarkably narrow”, the BIS called for more action by governments.
State spending should be focused more at “human and capital investment” to raise productivity and governments should focus on the underlying state of public finances, factoring in the effect of financial booms.
“For example, rising tax revenues during a housing market boom should not be interpreted as a permanent improvement in fiscal positions,” Mr Caruana said.
“There is an urgent need to rebalance policy in order to shift to a more robust, balanced and sustainable expansion.” the BIS said. “We need to abandon the debt-fuelled growth model that has brought us to this predicament.
Hyun Song Shin, head of research at BIS, suggested that central banks might review their mandate. “We should be looking at growth and looking at employment, too,” he said.
Cutting interest rates to deal with low inflation may be deepening the problem, he indicated. “The trade-off between the perception of how to deal with the problem and the long-term effects of the policy solution is not as good as it may seem,” he said.
The BIS’s foreign exchange reserves data showed a $668 billion decline globally last year. China accounted for $513 billion of that, as it sought to shore up the yuan. Middle East countries burnt through $140 billion of their reserves to offset falling oil prices.
