Central banks warn on the economy

A new report out by the Bank for International Settlements said that governments were delaying overhauls as central banks grabble with monetary policy.

Here’s the story from the Wall Street Journal:

Efforts by the world’s “overburdened” central banks to stabilize financial markets have allowed governments to delay necessary overhauls to their economies and banking systems, the Bank for International Settlements said in its annual report Sunday.

The warning from the BIS, a consortium of the world’s top central bankers, comes as uncertainty over the course of monetary policy, particularly in the U.S., has led to a steep selloff in equities and government bonds, threatening to touch off a new bout of global financial distress.

“It is becoming increasingly clear that central banks cannot do ‘whatever it takes’ to return still-sluggish economies to strong and sustainable growth,” said Stephen Cecchetti, head economist at BIS.

“Whatever it takes” emerged last year as a powerful verbal intervention by European Central Bank President Mario Draghi to signal the bank’s willingness to use its balance sheet, within its mandate, to prop up bond markets of ailing southern European countries if needed to preserve the euro.

Mr. Draghi’s remarks nearly one year ago, later backed up by a conditional bond-purchase program, were so successful at reducing Spanish and Italian bond yields that the bond facility has yet to be used.

But the BIS cautioned that stimulus efforts of central banks—interest rates near zero; abundant bank loans and asset purchases—come with unwanted side effects. The most dangerous, the report suggests, is that it takes pressure off governments to overhaul their economies and reduce debt while delaying necessary reduction of debt in the private sector as well.

The Guardian points out that markets plunged last week after the U.S. Federal Reserve Chairman Ben Bernanke said he is working to end quantitative easing and it’s time for central banks to look for a different role:

The bank’s intervention comes at a critical time, as the Federal Reserve is preparing the US public for the end of the quantitative easing programme under which it bought $85bn (£55bn) of bonds every month. In total, central banks in the world’s major economies, including the US, UK and Japan, now own assets worth 25% of those countries’ GDP.

Stock and bond prices plunged across the world last week after Ben Bernanke, chairman of the Federal Reserve, announced that he planned to begin “tapering” quantitative easing by the end of the year.

The regulating bank in Basle believes it is the right time for central banks to reconsider their role. “We are past the height of the crisis, and the goal of policy has changed – to return still sluggish economies to strong and sustainable growth. Can central banks now really do ‘whatever it takes’ to achieve that goal? As each day goes by, it seems less and less likely.”

Instead of more central bank stimulus, the bank would like to see governments take immediate action to repair public finances, finish the job of re-regulating the fragile banking sector and make markets work better.

It warns that record low interest rates and quantitative easing on a huge scale have dulled the imperative for politicians to act. “After all, cheap money makes it easier to borrow than to save, easier to spend than to tax, easier to remain the same than to change,” the report says.

 The report comes after European leaders were unable to agree on a way to avoid taxpayers having to pay for a possible collapse of the banking system, according to the New York Times:

The report was published a day after a political leaders’ meeting in Luxembourg had provided a vivid example of what the central bankers were complaining about. Despite debating well into the early morning on Saturday, European Union finance ministers could not agree on new rules to reduce the chances of taxpayers bearing the burden if commercial banks collapsed.

“We ran out of time,” Michael Noonan, the Irish finance minister, told reporters as he left the meeting at about 4 a.m. “There are still core issues outstanding, so we’ll need a full meeting next week, and there’s no guarantee it will reach conclusion.”

The message from the group in Basel was that central banks cannot enable such inaction indefinitely. “The balance between costs and benefits is deteriorating,” said Stephen Cecchetti, head of the monetary and economic department of the Bank for International Settlements, referring to central bank policies that have flooded the world with cheap money since the financial crisis began in 2008.

There are already clear signs of central bank retrenchment. The Federal Reserve chairman, Ben S. Bernanke, indicated last week that the American central bank was likely to wind down the purchases of bonds it has used to push down market interest rates. The European Central Bank seems to be running out of ways to stimulate the euro zone, and there is doubt about whether the Bank of Japan can maintain an ambitious policy to flood the economy with money and achieve 2 percent inflation.

As long ago as last summer, Mario Draghi, the European bank president, was publicly lamenting the limits of the central bank’s ability to address the broader problems of the European economy and calling upon political leaders to pursue structural solutions.

Let’s hope that the central banks and the European leaders are able to pull some type of solution together. Many people are watching to see what becomes of the discussions, especially investors and others watching their retirement accounts slowly drain.