Since the beginning of the financial crisis almost six years ago, central banks and fiscal
authorities have supported the global economy with unprecedented measures. Policy rates
have been kept near zero in the largest advanced economies. Central bank balance sheets have
doubled from $10 trillion to more than $20 trillion. And fiscal authorities almost everywhere
have been piling up debt, which has risen by $23 trillion since 2007. In emerging market
economies, public debt has grown more slowly than GDP; but in advanced economies, it has
grown much faster, so that it now exceeds one year’s GDP.
Without these policy responses of easy money, the global financial system could
easily have collapsed, bringing the world economy down with it. But the subsequent global
recovery has remained halting, fragile and uneven. In the United States, the expansion
continues, albeit at a moderate pace. In major emerging market economies, growth is losing
momentum. Most of Europe has fallen back into recession. At the same time, the general
downward trend in productivity growth has not been receiving enough attention from
policymakers.
As the risks mounted around mid-2012, central banks rode to the rescue yet again. The
ECB addressed market fears with the promise that it would do “whatever it takes” within its
mandate to save the euro. It followed up with a conditional programme to buy sovereign debt
of troubled euro area countries. Central Banks of the U.S., U.K. and Japan likewise pushed forward with additional expansionary measures.
As global financing conditions eased further, private credit continued to grow at a rapid
pace in some countries, lending standards weakened, equity prices reached record highs
worldwide, long-term yields hit record lows and credit spreads compressed. Even highly
leveraged firms could borrow at long-term rates far below the rates they had to pay before the
crisis.
But easy financial conditions can do only so much to revitalise long-term growth when
balance sheets are impaired and resources are misallocated on a large scale. In many advanced
economies, household debt remains very high, as does non-financial corporate debt. With
households and firms focused on reducing their debt, a low price for new credit is not terribly
relevant for spending. Indeed, many large corporations are using cheap bond funding to
lengthen the duration of their liabilities instead of investing in new production capacity. It does
not matter how attractive the authorities make it to lend and borrow – households and firms
focused on balance sheet repair will not add to their debt, nor should they.
And, most of all, more stimulus cannot revive productivity growth or remove the
impediments that block a worker from shifting into a promising sector. Debt-financed growth
masked the downward trend in labour productivity and the large-scale distortion of resource
allocation in many economies. Adding more debt will not strengthen the financial sector nor
will it reallocate resources needed to return economies to the real growth that authorities and
the public both want and expect.
As the stimulus is sustained, it magnifies the challenges of normalising monetary policy; it increases
financial stability risks; and it worsens the misallocation of capital.
Finally, prolonging the period of very low interest rates further exposes open economies to
spillovers that are now widely recognised. The challenges are particularly severe for the
emerging market economies and smaller advanced economies where credit and property
prices have been rapidly growing. The risks from such a domestic credit boom at a late stage of
the economic cycle are hard enough to manage. Strong capital inflows exacerbate such risks
and challenges for market participants and authorities; and they expose economies to large
sudden reversals if markets expect an exit from unconventional policies, as volatility during the
past few weeks seems to indicate.
Source: Bank of International Settlements, June 2013.
