Central Banks Are Issued Warning

Posted on June 30th, 2014 by Toni Burns

The Bank for International Settlements has sent out a very clear message of caution to governments around the world. It states that holding interest rates exceptionally low could turn the world economy upside down.

The Swiss bank released the contents of it’s annual report which claimed that major central banks need to be very wary of causing a “debt trap”.


The “bank of central banks” declared, “Central banks will find themselves behind the curve exiting too late or too slowly. Policy does not lean against the booms but eases aggressively and persistently during busts. This induces a downward bias in interest rates and an upward bias in debt levels, which in turn makes it hard to raise rates without damaging the economy.”

It added, “Private and public debts continue to grow, the economy fails to climb onto a stronger sustainable path, and monetary and fiscal policies run out of ammunition. Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent.”

The report also addressed the fragility of emerging markets highlighting China. It said, “Particularly for countries in the late stages of financial booms, the trade off is now between the risk of bringing forward the downward leg of the cycle and that of suffering a bigger bust later on”.

Their monetary and economic department head Claudio Borio is concerned that another crisis in the financial world could “spell the end to the current open global economic order.”  Mr Borio includes the Bank of England when he says that central banks are “focusing on the shorter term and losing sight of the more threatening underlying waves.” 

The International Monetary Fund are not in agreement with them.  The IMF wants the European Central Bank to relax monetary policy and undertake large scale asset purchases, should the need be necessary.

But the International Bank are opposed to that and their perspective is, “Good policy is less a question of seeking to pump up growth at all costs than of removing the obstacles that hold it back.”

The details of the Basel based bank’s report comes less than one week after Mark Carney delivered the Financial Policy Committee’s latest plans for the UK economy in the Financial Stability Report.


Mark Carney

The governor’s announcement means that the Bank of England will be the first leading central bank to utilise their macroprudential tools to help the UK economy. The Bank of England have been under pressure to prevent a possible housing bubble being led primarily in the South East of England, particularly in the capital.

However, the BIS appear not to support this step by suggesting, “These tools have proved very helpful in increasing the resilience of the financial system, but they have been only partially effective in restraining the build up of financial imbalances.”

Mr Carney has since said in an interview that he predicts UK interest rates to stabilise at about the 2.5 per cent figure.

But the BIS indicates that by implementing ‘the Taylor Rule’,  it would show that UK rates are lower than where they should currently be.

Economist John B Taylor introduced this rule and it’s now used as a guideline to manipulate interest rates. Three key elements are applied to his principle.

The three measures consist of:
1) the actual versus targeted inflation levels
2) the actual employment versus full employment levels
3) the appropriate short-term interest rate consistent with full employment. 


John Taylor

The Stanford economics professor told the Telegraph that “if the interest rate policy had been different for quite a while I think the economy would be stronger and you wouldn’t think about anything but higher interest rates.”

He explained further, “I would not say interest rates should rise this week or this month, but policymakers should get back to where people see interest rates be given the economic conditions so they understand how policy works better. These low rates cause a search for yield and risk taking which is an imbalance.”

About the author

Toni Burns Toni Burns is a Digital Marketing Specialist at Cash Sorted and writes the majority of our informative blog posts. She keeps on top of the finance industry and reports back on any changes that could affect our users. Toni loves skiing, eating out & listening to music.

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