Monday, July 4, 2016

BIS Annual Report - Time to End the "Debt Fueled Growth Model"

In its new 2016 Annual Report, the Bank for International Settlements (BIS) has repeated warnings that it has issued before. The report says "there is an urgent need to rebalance policy in order to shift to a more robust and sustainable global expansion." The report was issued along with two new speeches by BIS Officials Claudio Borio and Jaime Caruana

The speeches make it clear that BIS believes there has been too much reliance on "debt fueled growth models" and monetary easing policies by Central Banks. Below are some selected quotes from the report and speeches and then a few added comments.

Here some quotes from the overview of the Annual Report (bold emphasis is mine):

"Judged by standard benchmarks, the global economy is not doing as badly as the rhetoric sometimes suggests. Global growth continues to disappoint expectations but is in line with pre-crisis historical averages, and unemployment continues to decline. Less comforting is the longer-term context - a "risky trinity" of conditions: productivity growth that is unusually low, global debt levels that are historically high, and room for policy manoeuvre that is remarkably narrow. A key sign of these discomforting conditions is the persistence of exceptionally low interest rates, which have actually fallen further since last year.
The year under review saw the beginnings of a realignment in the forces driving global developments: partly in response to US monetary policy prospects, global liquidity conditions began to tighten and the US dollar appreciated; financial booms matured or even began to turn in some emerging market economies (EMEs); and commodity prices, especially the oil price, dropped further. However, global prices and capital flows partly reversed in the first half of this year even as underlying vulnerabilities remained.
There is an urgent need to re-balance policy in order to shift to a more robust and sustainable expansion. A key factor in the current predicament has been the inability to get to grips with hugely damaging financial booms and busts and the debt-fueled growth model that this has spawned. It is essential to relieve monetary policy, which has been overburdened for far too long. This means completing financial reforms, judiciously using the available fiscal space while ensuring long-term sustainability; and, above all, this means stepping up structural reforms. These steps should be embedded in longer-term efforts to put in place an effective macro-financial stability framework better able to address the financial cycle. A firm long-term focus is essential. We badly need policies that we will not once again regret when the future becomes today."

. . . . .

"Global growth of GDP per working age person slightly outpaced its historical average and unemployment rates generally fell in the year under review. Perceptions of economic conditions, however, were defined by further falls in commodity prices, large swings in exchange rates and lower than expected headline global growth. These developments hint at a realignment of economic and financial forces that have unfolded over many years. In EME commodity exporters, the downturn in the domestic financial cycle mostly compounded the fall in export prices and currency depreciations, with economic conditions becoming weaker. In general, tighter access to dollar borrowing amplified these developments. The anticipated rotation of growth failed to materialise, with activity in advanced economies not picking up as much as needed to offset slower EME growth, despite some upturn in domestic financial cycles in the advanced economies most affected by the Great Financial Crisis. Lower oil and other commodity prices have not yet triggered the expected fillip to growth in importers, possibly because some parts of the private sector are still nursing weak balance sheets. The scars of repeated financial booms and busts and debt accumulation also hang over global potential growth: factor misallocation appears to be holding back productivity, with debt overhang and uncertainty seemingly restraining investment."

. . . . 

Fiscal policy should be an essential part of the post-crisis macro-financial stability framework. As history shows, banking crises wreak havoc with public finances. Growing fiscal risks, in turn, weaken the financial system: directly, by undermining deposit guarantees and by weakening banks' balance sheets through losses on their public debt holdings; and indirectly, by limiting the authorities' ability to stabilise the economy through countercyclical fiscal policy. The tight two-way link between banks and public finances also creates the potential for an adverse feedback loop, in which financial and sovereign risks reinforce each other. Moving away from the present favourable treatment of domestic public debt in capital regulation to one that reflects more accurately sovereign risk is important to weaken this loop. But, by itself, it is not sufficient. Maintaining or rebuilding a sound fiscal position is key. Building sufficient buffers in a financial boom creates the room to repair balance sheets and stimulate demand if a crisis occurs. A stronger countercyclical stance may also help contain excessive growth in credit and asset prices. But the most important contribution to crisis prevention may come from removing tax provisions that unduly incentivise debt over equity, leading to too much leverage and greater financial fragility.

Overview of the Jaime Caruana Speech:

"Drawing on the Annual Report, the speech discusses the realignment taking place in the global economy and the required rebalancing of policies. The large exchange rate and commodity price movements that had played out even before the recent market disturbances can only be fully understood by considering long-term trends in the global economy. Rising debt, lower productivity growth and diminishing room for policy manoeuvre have contributed to a build-up of vulnerabilities that give rise to three threats: macroeconomic instability; the adverse effects of persistently low interest rates; and a loss of confidence in policymaking. Countering these threats requires that prudential, fiscal and structural policies take on a more prominent role. More realism and clarity about what central banks can and cannot achieve would facilitate the rebalancing. Recent shocks make this task more complex, but also more necessary."

Overview of Claudio Borio Speech

"Should monetary policy take financial stability into account? If so, what would such a policy look like? These questions have gained greater prominence recently as tensions between price and financial stability have increased, while new research has found that a leaning-against-the-wind strategy would yield little or no benefits in terms of output and inflation. Drawing on BIS research presented in the Annual Report, this presentation argues that a financial stability-oriented monetary policy can yield significant benefits. For this to be the case, such a policy would need to keep an eye on financial stability all the time, during the whole financial cycle, so that the economy never strays too far away from "financial equilibrium".


My added comments: These speeches are obviously designed to tie in with the Annual Report issued by the BIS. My take on this is that the BIS wants to encourage central banks and governments to think in terms of moving away from the current reliance on debt growth models and extraordinary monetary policies to deal with problems over the longer term. 

The suggestions made here by the BIS are probably easier said than done. It's interesting that in the same week all this new information is released by the BIS, we get the Brexit vote which throws markets into turmoil and requires central banks to basically do things in the short term that the BIS is asking them to move away from in the long term (extraordinary monetary easing).

It's a striking reminder that at any time events can unfold (potential crisis) that force an immediate response that may not jive with longer term goals. Also, in the real world (versus the theoretical world of charts, graphs, and models, etc) governments have to deal with actual voters. If voters do not go along with attempted policies, that trumps (no pun intended) all the models and the projections of how those policies might work. No model can predict with certainty how people will react to various events and policies as we have just seen in the UK with the Brexit vote. It's a real factor that must be taken into account.

Below are a few news articles covering this new information from the BIS:

CNBC- Time to End Debt Fueled Growth Models

Bloomberg - BIS Warns of Overreacting to Brexit

Wall Street Journal - BIS Warns of Risks to Global Growth

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