With five years of ultra-easy monetary policy slowly coming to an end, politicians need to make up for lost time and speed up needed reforms of labor and product markets so societies can more easily adjust and return to economic growth, the Bank for International Settlements (BIS) said.
Despite years of rock-bottom interest rates and massive asset purchases, global economic growth remains lackluster, unemployment high, public finances unsustainable and many households and firms are still struggling to restore financial balances. Total debt has continued to rise.
With the risks and side effects of easy monetary policy growing and the benefits dwindling, central banks - first and foremost the U.S. Federal Reserve - are now starting to look towards the exit. Easy monetary policy has helped overcome the global financial crises and nursed economies back to recovery, but time provided by central banks for households and firms to repair balance sheets and governments to restore fiscal health has largely been squandered.
“The time has not been well used,” the respected BIS wrote in its latest annual report.
“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 sector.”
As illustrated by the Federal Reserve’s decision last week to wind up quantitative easing later this year, overburdened central banks have reached a crossroad. Delaying the inevitable exit from very easy monetary policies just makes the exit more challenging.
“Alas, central banks cannot do more without compounding the risks they have already created,” said Swiss-based BIS, known as the central bankers’ bank.
Continuing with loose monetary policy, will only tend to encourage aggressive risk-taking, the build-up of financial imbalances and distorted prices. In addition, low rates in advanced economies have spilled over to emerging economies, pushing up exchange rates and creating credit and property booms.
Instead of retarding needed changes in societies with near-zero interest rates and further purchases of government debt, BIS said central banks must return to their traditional focus and thereby encourage policy makers to change.
“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,” said BIS.
Sluggish economic growth is not only causing hardship for millions of people, but also explains why central banks have continued to loosen policy over the last year and why “even more radical ideas have been entertained” BIS said, referring to nominal GDP targeting or monetization of fiscal deficits.
Unlike previous years, when BIS rarely ventured into specific public policy recommendations, the world’s oldest financial institution is not holding back in highlighting the reforms that it believes most economies need to tackle to return to strong and sustainable growth.
Continued financial reform and repair of the finances of households, firms and governments is necessary but not enough.
“Authorities need to hasten labor and product market reforms so that economic resources can shift more easily to high-productivity sectors,” Stephen Cecchetti told journalists as he completes his five-year term at the BIS as economic adviser.
BIS pointed out that long-run economic growth and labor productivity has been trending downward in most advanced economies well before the financial crises in 2007, suggesting that part of the slowdown may be due to other factors.
“From that point of view, the crises aggravated the slowdown, but it was not the only cause,” BIS said.
Slower investment in information technology, for example, accompanied a drop in U.S. productivity and the U.S. employment rate peaked around 2000 and has been steadily falling since then for reasons that are still being debated.
Another point raised by BIS is that in the countries at the center of the financial bust, the sustainable growth path was likely overstated as financial booms tend to conceal structural misallocations of resources – construction, finance and real estate - and imbalances are first revealed when things go bust. Using previous growth rates as a benchmark is therefore not only inappropriate, but it also leads to widespread disappointment with current growth.
In order to improve growth, those past misallocations have to be put right, BIS said.
In some countries, workers and capital will need to shift away from industries that over-expanded during the boom to other sectors. In other countries, such as Italy that did not see a housing boom, productivity must rise.
In the long run, economic growth comes from new goods and services, and innovative ways of producing and delivering them.
“Regulations that obstruct innovation and change will therefore slow growth,” said BIS, adding that hindering a reallocation of capital and workers across sectors “puts the brakes on the economic engine of creative destruction.”
As such reforms typically produces winners and losers, policy makers only tend to act when their hand is forced, said BIS, noting those countries that have endured the most intense market pressure in recent years have pushed through such reforms.