Wednesday, August 10, 2016

BIS Working Paper: Unconventional Monetary Policies - A Re-Appraisal

In July 2016 the Bank for International Settlements released a working paper by Claudio Borio and Anna Zabai that reviews the unconventional monetary policies that have been used in the past few years around the world. The paper is somewhat lengthy so below I have pasted in the Conclusion section to get a feel for what the paper talks about. Below that are some added comments.



Originally, the monetary policy measures central banks adopted in the wake of the financial crisis were regarded as unconventional; almost a decade on, they have become commonplace. 

We have argued that this development is a risky one. Unconventional monetary policy measures, in our view, are likely to be subject to diminishing returns. The balance between benefits and costs tends to worsen the longer they stay in place. Exit difficulties and political economy problems loom large. Short-term gain may well give way to longer-term pain. As the central bank’s policy room for manoeuvre narrows, so does its ability to deal with the next recession, which will inevitably come. The overall pressure to rely on increasingly experimental, at best highly unpredictable, at worst dangerous, measures may at some point become too strong. Ultimately, central banks’ credibility and legitimacy could come into question

In many respects, of course, extensive reliance on unconventional monetary policies is not so much the cause but the effect of deeper fault lines. One, discussed here, is the nature of the recession and subsequent recovery ushered in by the financial crisis. Another is the unbalanced post-crisis policy mix, which left monetary policy to carry the bulk of the burden (BIS (2016a)). Yet another one has to do with the forces that have kept inflation stubbornly low and below targets – forces that are not fully understood and have drastically narrowed central banks’ options (eg BIS (2014)). But a final one is arguably the less than fully adequate character of current monetary policy frameworks – frameworks focused on short-term inflation control and that struggle to take financial stability systematically into account, despite its potentially huge macroeconomic costs (eg Borio (2016)). But this, important as it is, is another story.
My added comments: Here we see yet another paper from key BIS officials warning that the unconventional monetary policies being used around the world are likely not sustainable. In the concluding remarks above they talk about them as "risky" and "subject to diminishing returns". They say that "short-term gain may well give way to longer-term pain". They point out the ability of central banks to "deal with the next recession, which will inevitably come" is shrinking. 

Going even further, they say:

"The overall pressure to rely on increasingly experimental, at best highly unpredictable, at worst dangerous, measures may at some point become too strong. Ultimately, central banks’ credibility and legitimacy could come into question."

I don't think that officials like these would talk about these policies being "at best highly unpredictable, at worst dangerous" unless they take the risk of all this being unsustainable seriously. 

Recently we ran this article featuring comments by highly respected central bank expert Robert Pringle. He went even further in talking about current monetary policies by giving us this quote:

"Current monetary policies are immoral because….

….they weaken the institution of money, the crucial coordinating mechanism of each and every society. Following the inequitable allocation of  losses from the great financial crisis,  policy-makers are also knowingly further widening inequalities and divisions in society. The monetary mandarins treat people as tools to the realisation of ends that they, not the people, have chosen. They also view people as so stupid they will not understand what is going on." 

The main point I would ask readers here to think about is that if people like this are taking these risks very seriously, we certainly need to as well. It's easy as time goes by and things seem relatively stable for the most part to simply lose interest in these issues or to just assume these problems will never turn into a real crisis that will impact us. Unfortunately, that is simply not the case and we would be unwise not to stay as alert and informed as we can. It's not easy because it's impossible to know what event might trigger a major crisis or when it might happen. But it is necessary as these officials and experts remind us along with their critics who also remind us that the present system is very unstable and not sustainable over the long term.

Here is a good question to ask yourself:  What plan do I have to deal with a situation where the credibility and legitimacy of central banks came into question by investors and the general public? 

The BIS working paper above says it is possible for that day to arrive as unlikely as that may seem to most people right now. How would the public in general react to that? It's an unknown factor in a complex and divided world. As individuals, we need to think about the various possible reactions and have a plan in mind to fall back on.

Note: I will add this article to the list of BIS and IMF systemic risk warnings we have documented here over the past couple of years.

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