Those low interest rate u-Zirpers at the BIS are back.
The Bank for International Settlements, often known as the central banker’s bank, seems to share little in common with its low interest rate-advocating cousins in places like the UK and the US. In fact, the latest annual report from the BIS is fairly scathing when it comes to prolonged easy monetary policy.
Here’s a taste:
But net flows of capital are not the only challenge; gross flows matter too, and they are staggeringly large. A sudden reversal of such flows could wreak havoc with asset prices, interest rates, and even the prices of goods and services in countries at both ends of the flows. Moreover, international flows make rapid credit growth possible even in the absence of domestic saving. The persistence of unusually low interest rates has played a role in encouraging and facilitating these flows.
Many of the challenges facing us today are a direct consequence of a third consecutive year of extremely accommodative financial conditions. Near zero interest rates in the core advanced economies increasingly risk a reprise of the distortions they were originally designed to combat. Surging growth made emerging market economies the initial focus of concern as inflation began rising nearly two years ago. But now, with the arrival of sharper price increases for food, energy and other commodities, inflation has become a global concern.
The logical conclusion is that, at the global level, current monetary policy settings are inconsistent with price stability.
Well. Tell central bankers what you really think BIS.
Of course, simply raising interest rates won’t be easy either. The world’s banks — including the central ones — seem to have got themselves into something of a bind after a three-year drip of liquidity.
Troubled financial institutions have made progress in cleaning up their balance sheets. But, again, there is work left to do. They have been valuing impaired assets at more realistic levels, discouraging evergreening of loans, retaining earnings and raising capital in the financial markets. But at the same time as ultra-low interest rates have given banks the breathing space to take the necessary actions, they have weakened incentives to pursue the clean-up. With the time for policy normalisation fast approaching, financial institutions need to quickly finish what they have started. The fact that the financial system has been building up significant interest rate risk as rock-bottom policy rates have persisted underscores the need for urgency.
Central bank balance sheet policies have supported the global economy through a very difficult crisis. However, the balance sheets are now exposed to greater risks – namely interest rate risk, exchange rate risk and credit risk – that could lead to financial losses. Rising long-term interest rates may result in actual losses if central banks sell bonds from their portfolios, or in potential losses under mark to market accounting. Central banks with large holdings of foreign currency-denominated assets are especially vulnerable to exchange rate risks: a sharp appreciation of the domestic currency would translate into losses on their foreign exchange reserves. Credit risks have been increasing since the onset of the international financial crisis as central banks have purchased (or lent against) lower-quality assets, such as asset-backed securities.
Much, much more in the full BIS report.