The world is defenceless against the next financial crisis, warns BIS

28 Jun 2015 | Author: | No comments yet »

BIS warns low interest rates could spell ‘entrenched instability’.

The world will be unable to fight the next global financial crash as central banks have used up their ammunition trying to tackle the last crises, the Bank of International Settlements has warned. Near-zero interest rates could become chronic in the world’s major economies unless ”a firm hand” is used to raise them back to more normal levels.

The international body that represents the world’s central banks has issued a stark warning that an unprecedented period of ultra-low interest rates mask deep weaknesses in the global economy and threaten to be the trigger for the next financial crisis. In its annual report, the Basle-based Bank for International Settlements says that what used to be considered “unthinkable” risks becoming the “new normal”, with clear risks for future stability. The BIS, which functions as a forum for global central banks, argues that low rates aimed at stimulating economic growth in the short term may actually do the opposite over longer periods. But it cautioned that global debt burdens and financial risks remained too high, while productivity and financial growth were too low, leaving policy makers with little room to maneuver. It said cheap money encourages more debt and creates financial booms and busts that leave lasting scars on the economy – with the result that central banks apply more cheap money to try to lift the economy. ”Rather than just reflecting the current weakness, low rates may in part have contributed to it by fueling costly financial booms and busts,” the BIS report said.

It added that monetary policy – the willingness of central banks to print money and keep borrowing costs low – was bearing too much of the burden and that governments needed to rely more on structural reform to secure sustainable growth. A number of countries, including Switzerland, Denmark and Sweden, have in recent months introduced negative rates, meaning investors have to pay to lend money to these states. Between December 2014 and the end of May, around $2.0 trillion in global long-term sovereign debt, much of it issued by euro area sovereigns, was trading at negative yields, BIS said. The result is too much debt, too little growth and too low interest rates. “In some jurisdictions, monetary policy is already testing its outer limits, to the point of stretching the boundaries of the unthinkable,” the BIS said. The current low rates “are a vivid reminder of the extent to which monetary policy has been overburdened in an attempt to reinvigorate growth,” Borio said. “They have underpinned the contrast between high risk-taking in financial markets, where it can be harmful, and subdued risk-taking in the real economy, where additional investment is badly needed,” he said.

The economies worst hit by the last crisis are now suffering the costs of persistent ultra-low rates, the organisation said, which could “inflict serious damage on the financial system”, sapping banks and weakening their balance sheets and their ability to lend. Mr Caruana said that during booms, workers and capital are shifted to slow-growing sectors, with a “long-lasting negative” impact on productivity growth. “Misallocated labour needs to move from these sectors to other parts of the economy,” he said.

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