Central banks 'fumble in the dark' as they cut rates - BIS

    The Bank for International Settlements (BIS), the world's oldest international financial institution, launched a stinging critique of central banks, saying the use of ultra-low interest rates to boost economic growth is ineffective and counterproductive because it encourages further debt and eases the pressure on politicians to undertake necessary reforms.
    BIS, known as the central banks' bank, said exceptionally low interest rates, unbalanced global economic growth and high debt are symptomatic of the failure of the policy framework used by central banks and threatens to entrench financial instability and chronic economic weakness.
    "Persistent exceptionally low rates reflect the central banks' and market participants' response to the unusually weak post-crises recovery as they fumble in the dark in search of new certainties," said Claudio Borio, head of BIS' respected Monetary and Economic Department since late 2013.
    In its annual report, Swiss-based BIS argues that the current malaise in the global economy is largely a result of a failure by policymakers to grasp how financial developments, especially debt, interact with economic activity and inflation in a world with closely connected economies.
   "Rather than just reflecting the current weakness, low rates may in part have contributed to it by fueling costly financial booms and busts," said BIS, adding: "The result is too much debt, too little growth and excessively low interest rates. In short, low rates beget lower rates."
    BIS, a hub of global central bank cooperation, said central banks' obsession with controlling short-term economic output and inflation must be replaced by policies - both national and international - that rely less on demand management and more on structural policies so as to abandon the debt-fuelled growth model that has become a substitute for meaningful reforms.
    The recommendations by BIS are hardly new as they echo the message in last year's annual report. But what stands out this year is a much sharper and more coherent analysis of the failings of the prevailing economic paradigm.
    This is a tribute to Borio, one of the pioneers in developing the understanding of financial cycles who became known in the early 2000s for arguing that financial imbalances - gauged by looking at the level of credit and property prices -  can build up in an environment of low inflation.
    Before the financial crises, which BIS warned about repeatedly, central banks were narrowly focused on keeping inflation low and therefore turned a blind eye to the forces that led to the global financial crises in 2008.
    To their credit, many central banks have begun to incorporate financial instability into their policy frameworks, but BIS argues it has to be at the core of the debate over economic policy.
    Policymakers still remain focused on closing output gaps and use policies that affect demand to eliminate that gap to achieve full employment and stable inflation. Although financial instability is now recognized as something that has to be addressed, the current cure is largely through prudential policy that is separate from monetary policy.
    For BIS, financial cycles provides it with a lens through which it becomes easier to understand why economic growth remains to sluggish and unbalanced five years after the end of the global financial cries despite low or even negative real interest rates, and high or growing debt.

Low volatility due to reduced economic uncertainty - BIS

    The current low level of volatility in financial markets, following a brief rise in July from geopolitical tensions, is partly due to reduced uncertainty about the global economy, according to the Bank for International Settlements (BIS).
    In its latest quarterly review, Swiss-based BIS examined the prolonged calm in financial markets with volatility of bonds, equities, exchange rates and commodity prices well below historical averages in early July and in several cases even below pre-crises levels.
    After a short-lived pickup in volatility in late July and early August, volatility as measured by the VIX volatility index had already dropped back to 12 percent as investor appetite recovered.
    "Volatility is generally lower during business cycle expansions than in recessions, when uncertainty about macroeconomic and firm-specific fundamentals tend to be higher," BIS wrote.
   Exceptionally accommodative monetary policy is likely to have played a role in driving volatility to such exceptional lows, by directly compressing volatility on fixed income markets.
    "More transparent central bank communication, forward guidance and asset purchases have also removed uncertainty about interest rate changes for medium- and longer-term maturities," BIS adds.
    Please click on www.bis.org to read the BIS September quarterly review.

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Will US escape inflation that follows money printing?

   (Following article is written by Michael Lombardi of Profit Confidential for Central Bank News. Central Bank News will occasionally carry articles by guest contributors if they are of interest to our readers.)

  Is the Federal Reserve ignoring the very basic law of economics…the law of diminishing marginal utility? You remember that term from economics in high school. The law of diminishing marginal utility states that the more of something you have, the lesser its impact on you.

    The Fed has been printing money in hopes of stimulating growth in the U.S. economy. As the Fed printed more paper money, its balance sheet grew to over $4.0 trillion.

    Below, I’ve made a table that looks at gross domestic product (GDP) growth in the U.S. each year since 2009, and where the balance sheet of our central bank stood at the end of each year.

U.S. GDP Growth vs. Growth in Size of Fed Balance Sheet

Year	YOY Change in GDP	Fed Balance Sheet (Trillions)	YOY Change in Balance Sheet
2009	-2.80%	$2.08	73.44%
2010	2.50%	$2.31	11.21%
2011	1.84%	$2.74	18.58%
2012	2.77%	$2.86	4.36%
2013	1.87%	$3.47	21.33%

Data source: Federal Reserve Bank of St. Louis web site,
 last accessed April 1, 2014.

 In the table above, you will notice something interesting; aside from 2009, there is no real correlation between the increases in the assets (paper money printed) on the Fed’s balance sheet and GDP growth. In fact, after all the money the Fed has printed, the U.S. economy grew last year at its slowest pace since 2011.

    The Federal Reserve predicts the U.S. GDP in 2014 will increase between 2.8% and three percent; that’s a jump of about 50% since 2013. (Source: Federal Reserve, March 19, 2014.) I believe this to be way too optimistic. (And as we have seen in the past, these projections are usually guided lower later in the year anyway.) 

    Since the beginning of 2014, we have been seeing dismal economic data suggesting the U.S. economy will not be growing as much as expected this year. The law of diminishing marginal utility is starting to become very evident; the money printing is not producing the positive effects on the economy like it did before.

    Examples of slow growth this year…

    Personal consumption, a big part of U.S. GDP, is soft, as U.S. retailers have been posting very soft sales increases this year.

    The number of new homes sold continues to decline, too. Existing-home sales are running this year at their lowest point since 2012.

    But in spite of the proof of slowing GDP growth, the failed policies of easy money continue to be the policy of choice. Recently, at the 2014 National Interagency Community Reinvestment Conference in Chicago, Illinois, Janet Yellen said, “…I think this extraordinary commitment is still needed and will be for some time, and I believe that view is widely shared by my fellow policymakers at the Fed.” (Source: “What the Federal Reserve Is Doing to Promote a Stronger Job Market,” Board of Governors of the Federal Reserve System web site, March 31, 2014.)

    No central bank in the history of mankind has printed as much new paper money as the Federal Reserve has over the past five years. And while economists and the Fed are not concerned with it today, my research shows that whenever this kind of money printing stopped in the past, the country printing the money subsequently encountered a very weak currency and rapid inflation. I don’t think the U.S. will escape this. In fact, I think inflation is already a big problem if we include the increase in food prices and energy prices that are excluded from the government’s official measure of inflation growth.

    (The article "Will the U.S. Escape the Rapid Inflation That Usually Follows Massive Money Printing?" was originally posted at Profit Confidential

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Korea's Shin to become BIS adviser, Borio to head MED

    Hyun Song Shin, professor of Economics at Princeton University, will become the new economic adviser to the Bank for International Settlements (BIS) while Claudio Borio, long-time BIS staffer and one of the world's most respected monetary economists, will head the BIS' Monetary and Economic Department (MED).
    It is the first time in the 83-year history of the BIS, known as the central bankers' bank, that the position of economic adviser and head of the MED has been split between two people. It is also the first time the BIS has chosen an economic adviser that is neither European or North American, illustrating the BIS' shift away from its European roots to being a truly global institution.
    Borio and Shin will become members of the BIS' executive committee and contribute to the general management of the BIS, the world's oldest international financial institution that is based in Basel, Switzerland. The BIS board comprises he world’s most powerful central bank governors, such as Ben Bernanke of the Federal Reserve, Haruhiko Kuroda of the Bank of Japan, Mario Draghi of the European Central Bank and Zhou Xiaochuan of the People’s Bank of China.
    Shin, a Korean national, takes up his new job as the seventh economic adviser to the BIS on May 1, 2014. In addition, he will be head of research and have primary responsibility for economic research.
    Borio, currently deputy head of the MED and director of research and statistics, takes over on Nov. 18, the day Stephen Cecchetti, current BIS economic adviser and head of MED, leaves after a planned five-year term that has witnessed sweeping changes to central banking.

Central banking will not return to pre-crises - BIS adviser

    The unprecedented response of central banks to the global financial crises has fundamentally changed the framework and nature of central banking by blurring the lines between fiscal and monetary policy, according to Stephen Cecchetti, outgoing chief economic adviser to the Bank for International Settlements (BIS).
    Now that the U.S. Federal Reserve is preparing to exit from quantitative easing, the issue for Cecchetti is what central banks are exiting to and what the future operating framework will be.
    One thing is clear to Cechetti: “We are not going to go back,” he told Central Bank News in an interview.
    Later today the board of the BIS is expected to pick a successor to Cecchetti, who is leaving as planned after a five-year term as adviser.
    As part of their response to the crises, major central banks slashed their policy rates to essentially zero and stuffed their balance sheets with assets that traditionally were never held by central banks, be it the Fed’s purchases of mortgage-backed securities of the Bank of Japan’s purchases of corporate debt.

BIS aims beyond central banks, Cecchetti leaves on a high

     Stephen Cecchetti, chief economic adviser to the Bank for International Settlements (BIS), is leaving Basel, Switzerland and heading back to his home in Lexington, Massachusetts on a high.
    This year’s annual BIS report was a blockbuster, creating more newspaper headlines than any of the institution’s previous 82 annual reports, a personal success for Cecchetti who has spent the last five years working to get the BIS message across to a wider audience than just central bankers.
    For Cecchetti, however, it’s still too early to tell whether this year's message was transmitted effectively and understood by policy makers, his main objective since he joined BIS in 2008.
    "Much of the press think we must be speaking to central banks but in fact our audience is wider" Cecchetti told Central Bank News in an interview.
     “The BIS needs to engage constituencies beyond the central banks in order to ensure that its message is effective,” he added.
    Later today, the BIS board is expected to announce the name of a new economic adviser who will succeed Cecchetti who only intended to serve one five-year term.

Financial cycle peaks coincide with crises - BIS paper

    Peaks in financial cycles of 16 years and longer tend to coincide very closely with crises that cause serious economic damage and the virulence of these cycles has increased since the mid-1980s, according to a working paper by economists at the Bank for International Settlements.

    Prior to the global financial crises, economists typically focused on business cycles and believed that interest rates captured the interplay between the financial and real sides of an country's economy. But the crises showed the failure of this understanding and the paper by the BIS economists is part of a wholesale rethink of the discipline of macroeconomics.

    The paper concludes that financial crises, or systemic banking crises, are linked to a policy regime of liberalizing the financial sector in an environment of monetary policy that is focused on price stability -- a finding that has major policy implications.

    "And we note that the authorities should watch out for what we call the “unfinished recession” phenomenon. Policy responses that fail to take (medium-term) financial cycles into account can help contain recessions in the short run but at the expense of larger recessions down the road," the paper said.

    For details, see the BIS working paper: "Characterising the financial cycle: don’t lose sight of the medium term! "

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