Central bankers know what’s wrong with the world economy, but are struggling to come up with a cure. That, at least, is the message from the latest annual report from the Bank for International Settlements. It worries that global growth is feeble and financial markets are piling up risks. Yet its proposed remedies of tighter monetary policy and structural reform are far from convincing.
The Basel-based forum for central banks was one of the few to spot the symptoms of the 2008 financial crisis before it struck. Its diagnosis of the world’s current economic malaise is equally lucid. Developed economies, struggling with heavy debt and risk-averse banks, have responded poorly to loose monetary policy. Investors, meanwhile, have interpreted low interest rates and minimal volatility as a signal to resume bad habits such as chasing up property prices and lending to risky companies.
When it comes to treatment, however, the BIS is less persuasive. It recommends a cocktail of measures including tighter monetary policy, balance sheet repair, and structural reforms to boost productivity. Yet this proposed therapy contains some large inconsistencies. It’s far from clear how households and companies that already have too much debt could cope with higher interest rates. The BIS also continues to fret about inflation, even though deflation looks the bigger danger at the moment. And its explanation of how structural reforms might help stimulate weak demand is unimpressive.
One of the main disagreements between economists is whether the world is running below its pre-crisis productive capacity, or whether much of the debt-powered growth of the boom years was illusory. The BIS is squarely in the latter camp. The only way back to regain health, it implies, is to stop borrowing so much and come to terms with lower future growth rates.
Yet if that analysis is correct, then its proposed cure is not nearly radical enough. If growth is going to remain low for a long time, then governments, companies and individuals will need to find a way of writing off a large chunk of the debts they have accumulated. That is a remedy the BIS is not yet willing to endorse.