BIS: Expansion should be put "on a sounder footing"

The Bank for International Settlements (BIS) advocates taking advantage of the current favourable situation in order to build resilience at both the national and international level. This entails, amongst other things, strengthening the economy's capacity to absorb shocks and adapt to new trends, writes the institution – also known as the central bank of central banks – in its latest Annual Report, adding that the build-up of financial imbalances should also be avoided.

Favourable underlying conditions

As the BIS sees it, the economic situation has undergone a complete transformation in the past year. "One good year has been sufficient for economic conditions to become the most favourable since the Great Financial Crisis (GFC)," reported Claudio Borio, Head of the Monetary and Economic Department at the BIS. He went on to state that growth has strengthened considerably and is forecast to return to long-term averages soon, with unemployment rates continuing to fall back in the direction of their pre-crisis levels and inflation rates moving closer towards central bank objectives.

The BIS believes that, while the hard data have improved, sentiment has improved to an even greater degree. To quote from its Annual Report: "Gloom has given way to confidence." As he unveiled the report, Mr Borio asked whether, in the light of this, sentiment has swung too far. "The doubts about the future derive from tensions that will have to be resolved at some point and from long-term developments that may eventually threaten growth," he warned.

Interconnected risks

In its report, the institution identifies four risks that, from its perspective, could jeopardise the sustainability of growth in the medium term: a rise in inflation; financial stress as financial cycles mature, weaker consumption and investment, and a rise in protectionism. According to the report, these risks are more closely interlinked than they appear. For instance, a return to protectionism could spark financial strains and make higher inflation more likely.

In the assessment of the BIS, all of these risks have been profoundly shaped by the GFC and the unbalanced policy response. These risks are rooted in the "risky trinity" that was addressed at length in last year’s Annual Report: unusually low productivity growth, unusually high debt levels, and unusually limited room for policy manoeuvre.

The BIS considers it critical for the economy’s growth potential to be raised at this point. "At the national level, this means rebalancing policy towards structural reforms, relieving an overburdened monetary policy, and implementing holistic policy frameworks that tackle more systematically the financial cycle," the Bank writes in this year’s Annual Report.  At the global level, this means reinforcing the multilateral approach to policy – "the only one capable of addressing the common challenges the world is facing".

The BIS takes a detailed look at the subject of globalisation in a chapter of the report that was published in advance. Here, it highlights the fact that tighter trade and financial integration have contributed to a remarkable increase in living standards – but that gains from trade have not always been evenly distributed. According to the report, adjustment costs and financial risks therefore need to be carefully managed. "Instead of retreating from the ties of global trade and finance, we should reinforce them," wrote BIS General Manager Jaime Caruana in the foreword to the chapter. "We must work together to create well-designed policies, both domestically and internationally," he urged.

Monetary policy on the road to normalisation

Nearly ten years on from the outbreak of the crisis, the BIS believes that monetary policy is in a period of transition. "Policy normalisation presents unprecedented challenges, given the current high debt levels and unusual uncertainty," the BIS explains in the Annual Report, before going on to state that normalising too slowly would raise central banks’ concern that they would fall behind the curve and have to catch up in a disruptive fashion. By contrast, normalising too quickly would raise the risk of short-circuiting the recovery. According to the BIS, a strategy of gradualism and transparency has clear benefits but is no panacea, as it may also encourage further risk-taking and slow down the build-up of policymakers’ room for manoeuvre.