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Easy money brings hard choices

Nations cannot be dependent on monetary policy alone to boost economic growth, the global financier tells David Chance    


Finance veteran: Agustin Carstens, who heads the Bank for International Settlements, has first-hand experience of a debt crisis from his time as Mexico’s finance minister. Photo: Bloomberg
Finance veteran: Agustin Carstens, who heads the Bank for International Settlements, has first-hand experience of a debt crisis from his time as Mexico’s finance minister. Photo: Bloomberg

Central banks saved the world during the financial crisis, but an over-reliance on easy money may well be the reason economic growth has been so tepid since then, one of the world’s top financiers has told the Irish Independent.

Agustin Carstens, who heads the Bank for International Settlements, the central bankers’ central bank, doesn’t believe the world is about to head off another cliff into a recession, but says that the current policy mix means that weaknesses show up more frequently in the global economy.

“We are settling for an environment of a sort of subdued potential growth and that’s a state where I don’t think we should be,” Mr Carstens said in an interview following his delivery of the annual Whitaker Lecture at the Central Bank of Ireland.

“The issue is that we cannot be solely dependent on monetary policy to assure a much higher potential rate of economic growth,” he said.

Sitting at the centre of the world financial system, he is in a good position to judge as it is the Bank for International Settlements that facilitates joint action by central banks.

Despite an unprecedented amount of policy support from central banks – the Federal Reserve, European Central Bank and Bank of Japan alone injected $15trn into their economies – the recovery from the 2008-09 crisis in the developed world has been among the weakest on record.

With global growth faltering, the US Federal Reserve last week called time on its policy of raising interest rates while the European Central Bank has indicated it will hold rates at zero for longer and has reintroduced a measure to inject cash into the banking system.

There has been talk of more radical measures from central banks to combat what some economists are calling ‘secular stagnation’, a long period of negligible or no economic growth.

These range from pushing interest rates even deeper into negative territory, expanding government spending to boost demand and using central bank balance sheets to finance government deficits.

He is wary of calls being made across the globe for governments to borrow and spend more at a time when interest rates are so low, saying it should be used on a selective basis.

“The possibility of much higher interest rates, of higher premia can arise quite quickly if there is a lot of fiscal profligacy so countries have to be very, very careful in using that instrument,” he said.

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That is a lesson Ireland learned the hard way during the global financial crisis and the years it has taken since then to return the budget to balance, even though debt levels remain high.

Mr Carstens himself has had first-hand experience of the dangers of a debt crisis – two years after he joined the central bank, Mexico defaulted on its debt in an episode that shook the world financial system and triggered the decade-long Latin American debt crisis.

He was finance minister when the 2008 crisis hit and famously took out a hedge on the country’s entire oil production that protected the economy against a crash in prices. In 2009, Mexico reaped a $5bn windfall from the hedge.

If you thought the financial crisis had put an end to borrowing, you would be wrong. Stimulated by low interest rates, global debt has surged by $27trn since 2016 to hit $244trn (€216trn) by the third quarter of last year. That is more than three times the economic output of the entire world.

Total government debt hit $65trn in 2018, up from $37trn a decade ago.

If priming the pumps with more central bank money or government spending is not the answer, then it only seems fair to ask Mr Carstens what is.

The first issue he cites is the rise in trade disputes and protectionism.

Data from the World Trade Organisation 2018 report shows that restrictive measures covering $588.3bn have been implemented in the 12 months to October 2018, more than seven times the level recorded a year earlier. President Donald Trump’s pledge to “Make America Great Again” has seen the United States implement a range of measures to restrict imports so as to bolster domestic industry and to shrink the country’s trade deficit.

“Trade disputes are something that are man-made and a more concerted effort to bring that into a steady state would be much better,” Mr Carstens said.

Populist measures like President Trump’s pushback on trade may work in the political arena, but appear not to have had the desired effect – the US trade deficit hit a record in 2018.

A lot of hard work has been put in to ensuring that banks pose less of a risk to the financial system and to ensure that taxpayers do not end up on the hook for their failure, as they did here.

Regulators have also worked to put in place measures that limit the extent to which financing amplifies economic cycles, such as capital requirements for banks and loan-to-value and loan-to-income rules that have been implemented by the Central Bank of Ireland.

Mr Carstens says that, so far, the measures – some of which are overseen by his organisation – appear to be “giving a positive result”, although he cautions that there are few easy choices.

Making labour and product markets more flexible and implementing post-crisis financial regulatory reforms are also key to securing long-term growth, according to the BIS.

“The path between growth and financial sustainability is not such a wide path and we need to get the right balances. That is sometimes an elusive quest,” he said.

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