BIS Warns About Destabilizing Low Interest Rates

The financial media is all atwitter (no pun intended) over the Bank of International Settlement’s just released annual report, since it shook a stern finger at central banks for keeping super low interest rates and warned them about the difficulty of renormalizing without kicking up a lot of upheaval.

It’s hardly news that getting out of the corner that the Fed and ECB have painted themselves in won’t be easy, as the taper tantrum of last year demonstrated. The ECB is thus urging central banks to have a hawkish bias, based on the notion that that protracted low rates are destabilizing. That’s highly likely to prove to be true in the long run, as investors continue to reach for return in a low interest rate, low volatility environment. But the BIS implicitly endorses austerity, when it’s austerity that has led to the perverse mechanism of falling back on a protracted period of super low interest rates to keep banks and through the confidence fairy, economies chugging along despite that. We can see how well that is working in the US and Europe. The US “recovery” is running just above stall speed, and Europe’s is a technical recovery.

So while some of the BIS’ warnings are valid, it chooses to ignore that the reason these low interest rates were implemented in the first place was due to poor criss responses, a fact set it omits.

So on the one hand, the BIS correctly warns about the risk of overheating financial markets as a result of super low interest rates. As the Financial Times put it:

While the global economy is struggling to escape the shadow of the crisis of 2007-09, capital markets are “extraordinarily buoyant”, the Basel-based bank said, in part because of the ultra-low monetary policy being pursued around the world. Leading central banks should not fall into the trap of raising rates “too slowly and too late”, the BIS said, calling for policy makers to halt the steady rise in debt burdens around the world and embark on reforms to boost productivity.

In its annual report, the BIS also warned of the risks brewing in emerging markets, setting out early warning indicators of possible banking crises in a number of jurisdictions, including most notably China.

Some related discussion from the report proper:

Financial markets have been acutely sensitive to monetary policy, both actual and anticipated. Throughout the year, accommodative monetary conditions kept volatility low and fostered a search for yield. High valuations on equities, narrow credit spreads, low volatility and abundant corporate bond issuance all signalled astrong appetite for risk on the part of investors. At times during the past year, emerging market economies proved vulnerable to shifting global conditions; those economies with stronger fundamentals fared better, but they were not completely insulated from bouts of market turbulence. By mid-2014, investors again exhibited strong risk-taking in their search for yield: most emerging market economies stabilised, global equity markets reached new highs and credit spreads continued tonarrow. Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally…

Through its impact on risk-taking behaviour, monetary accommodation had an impact on asset prices and quantities that went beyond its effects on major sovereign bond markets. Credit spreads tightened even in economies mired in recession and for borrowers with non-negligible default risk. Global investors absorbed exceptionally large volumes of newly issued corporate debt, especially that of lower-rated borrowers. And, as the search for yield expanded to equity markets, the link between fundamentals and prices weakened amid historically subdued volatility and low risk premia.

Gee, what about Bernanke/Yellen/Draghi put don’t you understand? Well, actually they do:

Frameworks that fail to get the financial cycle on the radar screen may inadvertently overreact to short-term developments in output and inflation, generating bigger problems down the road. More generally, asymmetrical policies over successive business and financial cycles can impart a serious bias over time and run the risk of entrenching instability in the economy. 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 – a debt trap. Systemic financial crises do not become less frequent or intense, 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. In this context, economists speak of “time inconsistency”: taken in isolation, policy steps may look compelling but, as a sequence, they lead policymakers astray.

This sort of thing sounds all well and good until you read more carefully: the “fiscal policies run out of ammunition” part. The BIS simply does not grok that you can’t cut deficits without having producing even larger contraction in the economy, worsening debt to GDP ratios. The IMF ‘fessed up to that last year but it appears the BIS did not get the memo.

So the report urges that countries need to put more emphasis on “structural reform” which means balancing budgets and deregulating labor markets even further. Someone needs to send them the video in which venture capitalist Nick Hanauer explains that you can’t kill consumer (how also happen to be laborers) and expect to have a robust economy.

Bill Mitchell explains how the BIS mouths some of the right words but recommends more of the same failed neoliberal medicine:

The BIS tell us that the GFC was a ‘balance sheet recession’. This is true and highlights that it is imperative to understand the nature of any real downturn because when they are linked to financial downturns the consequences for the economy and the correct policy response is different to situations when the real cycle is self-promoting….

The sequence of events that define a balance sheet recession are:

• The private sector builds up massive debt levels to buy property and speculative assets.
• The asset prices rise as demand rises but then eventually the bubble bursts and the private sector is left with declining wealth but huge debt.
• The private sector then start restructuring their balance sheets – and stop borrowing – no matter how low interest rates go.
• All effort is devoted to paying back debt (de-leveraging) and households increase their saving and reduced spending because they become pessimistic about the future.
• A credit crunch emerges – not because there is enough funds but because banks cannot find credit-worthy borrowers to lend to.
• Attempts at pumping liquidity into the banks will fail because they are not reserve-constrained. They are not lending because no-one worthy wants to borrow.
• The faltering spending causes the macroeconomy to melt and output collapses and unemployment rises.
• Balance sheet restructuring for the private sector is a long process of saving and debt retrenchment.
• With this private contraction (reducing debt, saving) the only way out of the balance sheet recession is via public sector deficit spending.

Increased public deficits above the norm are required for an extended period to support income growth that allows the private sector to save and restore the viability of their balance sheets.

The BIS clearly understand that the private debt dynamics are still precarious. But they go into denial when they claim that “More emphasis on repair and reform implies relatively less on expansionary demand management” (p.15)…

The BIS claim that:

After the initial fiscal push, the need to ensure longer-term sustainability has been partly rediscovered. This is welcome: putting the fiscal house in order is paramount; the temptation to stray from this path should be resisted. Whatever limited room for manoeuvre exists should be used, first and foremost, to help repair balance sheets, using public funds as backstops of last resort. A further use, where the need is great, could be to catalyse private sector financing for carefully chosen infrastructure projects … Savings on other budgetary items may be needed to make room for these priorities.

This is the austerity mantra that, in part, led to the crisis in the first place.

I suppose we can’t expect better from a central bank to central banks. So the beatings will continue until morale improves.

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  1. Moneta

    These low rates are a clear signal that retirees or near retirees should be shrinking their lifestyles drastically. Instead of using the last 5 years as a restructuring period, they got suckered into thinking that the credit crisis was a badly managed blip, so they are staying put in their living arrangements and going into higher risk securities to get their 6-10% returns.

    But then again, you can’t have a mass movement into downsizing when the housing stock was not built with that systemic feature in mind.

    If you think it has been bad since 2008, well chances are it’s going to get uglier.

  2. Eleanor

    I don’t know about blaming retirees. Some are in the stock market, I am sure, though common wisdom says that retirees should not be. Many don’t have anything more than their Social Security, which gets spent monthly. I think the real problem is giant pension funds and the rich looking for decent returns.

  3. ArkansasAngie

    Austerity? What austerity?

    Not everybody agrees with the idea that (MMT) printing to the moon and back will give you the results you want. Economic models are a self-fulfilling Prophesy incarnate … except when they don’t work.

    The current Modis O only helps those who should be facing moral hazard … uh … bankruptcy.

    Lesser of two evils? Nah … door number 3 please.

    1. jgordon

      These people do take their pet theories about how economies are supposed to run way too seriously, don’t they? So much so that they often imagine that the reason people don’t agree with their bizarre ideas/proposals is simply because people don’t understand them well enough… Right.

      Anyway, this stuff is all the result of an elaborate mental fetish/blindspot that values the consumption of goods and services over quality of life, happiness, and functional ecosystems. Which is frankly bizarre. Wealth is not the accumulation of manufactured products and immaterial currency units; that is sickness. Wealth is clean air and water not contaminated with toxic chemicals. Wealth is functional ecosystems that can support rich and diverse life. A Wealthy life means pursuing the knowledge to make those things happen, with the fact that all human beings are of high and equal value and that there is an appropriate and positive role for us in the ecology of the planet always in mind. Those who pursue this industrial economic paradigm, no matter how “equitable” a form it may take, are only pursuing collective suicide and ecocide.

  4. Tyler

    Since we need income growth that would allow the private sector to save and restore the viability of their balance sheets, why not raise the federal minimum wage to $20?

  5. Jim Haygood

    ‘The BIS simply does not grok that you can’t cut deficits without having producing even larger contraction in the economy, worsening debt to GDP ratios.’

    This is alcoholic logic applied to finance: since cutting back on my daily fifth of gin would give me the shakes, my health demands stable or even increasing gin consumption. It’s only prudent!

    1. John Zelnicker

      It’s not alcoholic logic, it’s accounting fact. If you cut deficits the economy will shrink and the GDP figure will fall faster than the debt amount, so the debt to GDP ratio will necessarily increase. Just look at the data from the Eurozone since 2007.

      1. craazyman

        what if corporations sitting on trillions in cash actually spent the money?

        why won’t they?

        does the momma or the poppa make the baby?

        Economics is a mental disorder!

        1. MyLessThanPrimeBeef

          It follows, and I concur, that modern economics is a modern mental disorder.

          And to believe in any modern economics theory is to catch that modern mental disorder.

          1. craazyman

            so true, so true. they all crack me up hilariously, wistfully, sadly, contemplatively. I think of somebody like Milton Friedman with his big glasses and assembly-line mind closed and certain like a weld on metal. They’re all like that. Just about all anyway. Grinding away with equations and numbers and haughty self-assurance, bludgeoning their own mind light into a deformed and deranged darkness, champions of a proud and priggish sterility. Where is there in there for reality to enter? Where is there in there for fantastic illuminations and dialectical visions? Where is there for truth and beauty? No where. They’re all like that. Numbers and numbers and numbers and numbers join together in a dense chain of opacity fused by a self-referential syllogisitic logic that even thought itself constricts, bound so heavily into a singular point of onanistic obsession it explodes like a supernova from the force of its own disorder it becomes the only thing it ever was to begin with — politics. It’s a mental disorder. To look at a whole and to see only a half, to look at a sphere and see only a circle, to look at reality and see it slide away until it’s only the model, and then to believe it utterly until it’s a god. It’s a mental disorder. All of it. It should be a division of psychicatry and instead of PhD they should get MD for mental disorder. They need a doctor, they shouldn’t be one themselves!

        2. Auburn Parks

          Why would they invest in plant and people when they can already produce the current level of demand? On a macro level, business investment is the means by which labor gets replaced with machines. And thats totally fine if you don’t lose the aggregate demand that those formerly employed or higher paid people were providing. And of course, absent a complete reversal of 40 years of neo-liberal policies that have led to our current national income share breakdowns, there is only one institution that can make up the aggregate demand. And that is of course the only institution on Earth with the authority to create US Dollars, Congress.

      2. Jim Haygood

        In 1994, I claimed that Bill Clinton’s deficit-cutting tax increase would provoke a recession. But it didn’t. Concurrently, Greenspan stepped on the monetary gas, and groaf continued.

        Deficits and GDP growth aren’t tightly and predictably linked, any more than M2 money supply and GDP growth are.

        If permanent deficits are needed to keep the economy’s head above water (arguably the case on Planet Japan), then you’re looking at an unsustainable situation — vely dangelous!

        1. Auburn Parks

          And what is it exactly thats unsustainable about permanent surpluses for the private sector?

    2. Yves Smith Post author

      It’s not “alcoholic logic”. It’s empirical fact. The IMF admitted that last year when it said fiscal multipliers are typically greater than one. This was huge news in economics circles, that the IMF’s research section was saying officially that austerity didn’t work, but guess you didn’t pay attention since it conflicts with your prior beliefs.

      1. Bobbo

        And yet it is also empirical fact that piling on additional debt is producing less and less growth per dollar or debt — so it seems to be like a damned if you, damned if you don’t situation. Sure you can deficit spend for the short term to stimulate demand. But what happens if cyclical private sector demand doesn’t come back because of malinvestment and inability to find true price discovery? Austerity was a disaster because it was accompanied by monetary stimulus that prevented the market from clearing — a worst of both worlds policy. What we need is a system-wide reset, and that will necessarily require large government deficits to help jump start after the crash. But even then we should think long and hard about what to spend the money on. Hopefully this time around the focus will be on rebuilding infrastructure rather than goosing pork spending. We need to move away from the “spend the money on anything, just keep it flowing” mindset.

        1. Yves Smith Post author

          When the IMF publishes something and has follow-up statements by top officials that are utterly at odds with its most fundamental policies, and it gets front page news in the Financial Times and is widely touted in the econoblogosphere, you are telling me we should ignore it because it contradicts your prior beliefs?

          1. OpenThePodBayDoorsHAL

            I think fiscal multipliers would be fine if the fiscal got multiplied into something that increased productivity. It doesn’t. Instead we borrow to fund things like new ways to kill people on the other side of the planet, new ways to impose regulation in every last little corner of society, and new ways to keep citizen freedom of movement and thought in check. On a personal scale we borrow to fund consumption.

    1. MyLessThanPrimeBeef

      Poverty is best addressed with remedies that aim at targets that at least are close to the causes.

      For example.

      A wealth tax with 100% of the money going to the people directly.
      GDP sharing
      Less worker exploitation
      Money creation via the People spending it into existence

      Massive fiscal stimulus via the government spending is another form of trickle down with 2 problems

      1. Time lag
      2. Cuts by the middle men (i.e. corporate contractors, especially Military Industrial Complex corporate contractors)

    2. Carla

      Tyler, I agree with your earlier comment: raise the minimum wage to $20 an hour. Also with someone else, figure out how to incent corps to spend their piles of cash on worthy pursuits. Also rebuild the g.d. infrastructure already, starting with water systems and bridges. But how we accomplish this while corporations enjoy Constitutional rights, and money is speech protected by the First Amendment, I have no idea. I mean, corporations have freedom of religion — whoever’d thunk it?

  6. financial matters

    Yes, this is a pretty amazing statement from the BIS. “A further use, where the need is great, could be to catalyse private sector financing for carefully chosen infrastructure projects … Savings on other budgetary items may be needed to make room for these priorities.”

    That’s what we need are more private toll booths and parking meters while we cut Medicare and social security.

    I prefer Wray’s approach from the other article today. “For those who’ve got Econ 101 under their belt, it is based on the loanable funds notion that “saving finances investment”. As we’ve known since Keynes, that is precisely wrong. I won’t go into it here, but it is best to think of this the other way round: investment creates the income that can be saved.”

    We need investment to get people working productively. This includes taking care of people’s social needs.

    (I just watched a good movie on Barbara Castle, ‘Made in Dagenham’)

    “Today, when her attempt at union legislation looks insignificant compared with what was to come, when drink-driving is (nearly) socially unacceptable and safety belts treated as part of the process of starting the car, it is for introducing equal pay that Barbara is most warmly remembered.

    For a politician who rejected the segregation of women’s issues as a way of diverting attention from socialism, who dreamt of a minimum wage, who fought to outlaw private practice and paybeds from the NHS and campaigned for a genuine global redistribution of wealth, equal pay seemed a relatively minor achievement.

    But for all her radicalism she also understood that change usually comes in increments. And even incremental change only happens when there is a radical individual demanding much, much more.”

    1. LucyLulu

      ” investment creates the income that can be saved”

      I find this useful when thinking about or trying to explain fiscal stimulus and deficit spending. Capitalism, and the “American Dream” is based on entrepreneurs being funded (going into debt), in order to go on and make their riches. IIRC, Henry Ford issued stock worth $100K to build his first car, sold for $850. When the Dodge Bros brought their suit to force Ford to pay dividends, annual dividend payouts were $100K. A few years later they sold their 10% holdings for $20 million. “You have to spend money to make money”, is an argument my father, a Goldwater/Rand conservative, used to make.

  7. Doug Terpstra

    As I see it, central banks have assumed the role of the Soviet Central Committee, in which everything is rigged for the narrow benefit of a tiny elite. Trade is thoroughly rigged against labor and small upstarts, the stock market is rigged thru HFT, stock buy-backs, rate fixing, gold fixing, and energy/utility price-fixing, as well as central bank buying of stocks and bonds directly — all of it enforced by heavy Pravda-press propaganda, an intrusive intelligence regime, police-state violence, and bloated militarism. This is likely to be the last gasp of supply-side-on-steroids as the Politburo inevitably implodes of its own wretched excess. How long before we tear down the wall between corporate-finance totalitarianism and popular democracy?

    1. MikeNY

      I concur that the Fed is a de facto central planner. They have a model for how the US economy is supposed to perform, and they will ENFORCE that model, if they have to blow up the entire world to do it.

  8. susan the other

    Good post. I wonder what the BIS wants to do with depression level unemployment and global GDPs in the toilet. Guns and Butter is always pretty expensive. So gotta cut the butter. The BIS pretends to oversee the puppeteers of this age of conflict, but it does not make any decisions about war and the cost of war. Without enough butter economies worldwide have collapsed. This happened a few years after the rich insiders all absconded with their hot trillions c. 2001. All that money which fled is now parked offshore, just waiting for interest rates to rise. That’s 30 trillion dollars, each one of them hoping for a good investment. Let’s just imagine what that would do. There must have been promises by the neocons before Iraq that there would be great opportunities for all that money. But in the meantime, war was gonna eat up all the resources. Almost 15 years ago Rummy named it “Odyssey Dawn.”

  9. impermanence

    No matter when/how this financial crisis resolves itself, a queue will be forming soon after, as the opportunity to spend future income is simply too enticing for the average human being to resist.

    It has been known for thousands of years that usury is destructive on so many different levels, yet these parasitic vermin crop up again and again and again, dazzling the masses with their financial wizardry that allows the average man to live well beyond his means, the price being his very soul.

    We are no better than those who have come before us. We allow the most sociopathic in our society free reign over the majority who just want a shot at living a decent life. Shame on us all.

  10. Auburn Parks

    “calling for policy makers to halt the steady rise in debt burdens around the world and embark on reforms to boost productivity.”

    This was my favorite part. Its a beautiful display of the ignorance of the mainstream economic establishment. Productivity increases reduce the need for labor. Counting on productivity increases to fuel job creation is like trying to start a fire with a bucket of water, its oxymoronic. And this is especially true given the modern split between productivity gains and real wage increases.

    Don’t get me wrong, I’m in no way against productivity increases as its the basis for improving our living standards. But unless we can revert to a 1950’s share of national income going to labor or we simply cut everyone checks every month (BIG) in order to increase incomes and spending, productivity increases offer zero hope of improving the macro economies of all developed nations.

  11. Roland

    Austerity is not so much the problem, the real problem is the distribution of austerity.

    With our current low-interest regime, we have austerity for the working class, while the bourgeoisie enjoy the best growth ever.

    Perma-growth avoids austerity, but at a high cost to the world and to the future.

    The correct way out of our balance sheet recession is not through unlimited spending by the central authorities. Instead, the answer is to pursue distributed degrowth, along with the prompt and massive annihilation of most financial assets controlled by the bourgeoisie.

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