The below speech by the Bank for International Settlements’ (BIS) general manager, Jaime Caruana, summarises the BIS’ 204-page Annual Report warning against continued monetary stimulus by central banks.
According to the BIS, central bank balance sheets have roughly doubled since the onset of the Global Financial Crisis (GFC), from $US10 trillion to around $US20 trillion:
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.
The BIS argues that continuous monetary stimulus has created a variety of problems, including “aggressive risk-taking”, “the build-up of financial imbalances”, and further “misallocation of capital”.
It believes the central bank mantra of doing “whatever it takes” to boost growth has outlived its usefulness, and that “central banks cannot repair the balance sheets of households and financial institutions. Central banks cannot ensure the sustainability of fiscal finances”.
Can central banks now really do “whatever it takes”? As each day goes by, it seems less and less likely… Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now.
Monetary stimulus alone cannot provide the answer because the roots of the problem are not monetary. Hence, central banks must manage a return to their stabilisation role, allowing others to do the hard but essential work of adjustment.
Many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity
Continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system…
Extending monetary stimulus is taking the pressure off those who need to act. In the end, only a forceful programme of repair and reform will return economies to strong and sustainable real growth…
Overindebtedness is one of the major barriers on the path to growth after a financial crisis. Borrowing more year after year is not the cure…in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits.
The BIS also notes that losses on US Treasury securities could reach $1 trillion (8% of GDP) if average yields rose by 300 basis points, with even greater losses likely in some other developed economies:
Consider what would happen to holders of US Treasury securities (excluding the Federal Reserve) if yields were to rise by 3 percentage points across the maturity spectrum: they would lose more than $1 trillion, or almost 8% of US GDP (Graph I.3, right-hand panel). The losses for holders of debt issued by France, Italy, Japan and the United Kingdom would range from about 15 to 35% of GDP of the respective countries. Yields are not likely to jump by 300 basis points overnight; but the experience from 1994, when long-term bond yields in a number of advanced economies rose by around 200 basis points in the course of a year, shows that a big upward move can happen relatively fast.
And while sophisticated hedging strategies can protect individual investors, someone must ultimately hold the interest rate risk. Indeed, the potential loss in relation to GDP is at a record high in most advanced economies. As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care.
The 9-page BIS summary speech is below, whereas the full 204-page Annual Report can be downloaded here.