FRANKFURT — Near-zero interest rates could become chronic in the world's major economies unless "a firm hand" is used to raise them back to more normal levels. That is the message in the annual report issued Sunday from the Bank for International Settlements based in Basel, Switzerland. The BIS, which functions as a forum for global central banks, argues that low rates aimed at stimulating economic growth in the short term may actually do the opposite over longer periods. It said cheap money encourages more debt and creates financial booms and busts that leave lasting scars on the economy — with the result that central banks apply more cheap money to try to lift the economy. "Rather than just reflecting the current weakness, low rates may in part have contributed to it by fueling costly financial booms and busts," the BIS report said. "The result is too much debt, too little growth and excessively low interest rates. In short, low rates beget lower rates." Major central banks have kept low benchmark rates in place to stimulate the economy after the shock delivered by the global financial crisis of 2007-2009. The idea is that low rates make it easier for people to borrow, spend and invest. The Fed's benchmark rate is a range between 0 and 0.25 percent; the ECB's 0.05 percent; the Bank of England's 0.50 percent, and the Bank of Japan's 0.10 percent. Low rates have driven down mortgage rates, enabling homeowners to refinance, and they have helped boost stocks. But they have wiped out years of income for savers — and put pressure on insurance companies and pension funds. The Fed is looking at whether to finally raise rates, but has held off because inflation remains low and growth in the United States still uncertain. Many economists think an initial hike may come in September. The Fed cautions that it will only raise rates slowly. The BIS report didn't mention individual countries. It argued that inflation is an uncertain guide to whether the economy is strong enough to weather a rate increase. It also said that keeping rates so low for so long draws money into less productive areas of the economy. Rate increases could cause financial assets like stocks to fall. But the likelihood of turmoil is only increased by waiting, the BIS said. It argued that "monetary policy normalization should be pursued with a firm and steady hand." Keeping rates anchored at these historic, ultra-low levels threatens to inflict “serious damage” on the financial system and exacerbate market volatility, as well as limiting policymakers' response to the next recession when it comes. “Risk-taking in financial markets has gone on for too long. And the illusion that markets will remain liquid under stress has been too pervasive,” the BIS said in its 85th annual report. “The likelihood of turbulence will increase further if current extraordinary conditions are spun out. The more one stretches an elastic band, the more violently it snaps back.” Claudio Borio, head of the BIS's Monetary and Economic Department, summed up the state of the global economy and financial system as one of “too much debt, too little growth and too low interest rates.” The first US interest rate hike in almost a decade is now on the horizon and when the Federal Reserve does move, it will mark a turn in the global monetary policy tide. No fewer than 29 central banks have eased policy to some degree this year to boost growth, ward off the threat of deflation, or both. The most notable of these has been the European Central Bank's 1.1 trillion-euro “quantitative easing” programme of bond buying, launched in March and due to run through to September next year. In strong language for the usually reserved BIS, it said extraordinarily loose monetary policy on a global level can cause “pervasive mispricing” in asset markets and that stocks and some corporate bond markets are now “quite stretched”. “In some jurisdictions, monetary policy is already testing its outer limits, to the point of stretching the boundaries of the unthinkable,” the BIS said. A return to more normal policies will be “bumpy”, not least because low rates have given rise to a “faulty debt-fuelled global growth model” - precisely what caused the crisis in the first place. Central banks have carried the burden of ensuring the post-crisis recovery for too long, BIS said. Now longer-term policies to secure the stability of the global economy and financial system must be put in place, it said. The leeway to do this opened up by the 60 percent plunge in oil prices between June last year and January this year is an opportunity governments should not pass up, the BIS said. “Nothing is inevitable about this,” it added. A failure on the part of governments, central banks and financial regulators to adopt more “prudent” policies would risk “entrenching instability and chronic weakness.”— Agencies
