A characteristic of the global financial and economic crisis that erupted in 2008 is that central banks have usurped the role of policy maker in sovereign states from the politicians. In the absence of coherent economic and fiscal policies in the United States, Japan, the eurozone and United Kingdom, central bankers have employed their power over the printing press with unprecedented vigor, unleashing a tidal wave of liquidity in a desperate effort to stave off a global economic depression. With the manipulative aplomb of a snake charmer, they have sought to push down interest rates to a point where short-term rates in most advanced economies are at virtually zero, while arousing confidence from investors and consumers who would have otherwise have little to cheer about.
The central bankers, in the minds of many, are the heroes of the economic crisis, supposedly saving the global economy from credit atrophy and demand destruction while the feckless politicians stood by helplessly. In case you would otherwise be unaware of the supposedly epic achievement performed by the central bankers, they have engaged themselves in a massive public relations drive during the crisis, paralleling their mega-liquidity dumps, seeking to persuade the public that central banks have become the new temples of salvation in an otherwise bleak economic and fiscal dystopia.
There has now emerged a strong voice that seems be throwing a wet blanket over the self-adulation that has become a byproduct of central banks. Jaime Caruana is a name largely unknown to the public at large, but intimately familiar to every central banker. He is the general manager of the Bank for International Settlements; the BIS serves as a global clearing house for central banks. Here is what Caruana had to say at the recently-concluded annual meeting of the BIS:
"Extending monetary stimulus is taking the pressure off those who need to act. Ultra-low interest rates encourage the build-up of even more debt. In fact, despite some household deleveraging in some countries, total debt private and public, has generally increased as a share of GDP since 2007. For the advanced and emerging market economies , it has risen by about 20 percentage points of GDP, or by $33 trillion -- and rising government debt has been the main driver. This is clearly not sustainable. Low rates have allowed the public sector to postpone consolidation at the risk of a further deterioration in sovereign credit quality and damage to longer-term growth. There is plenty of evidence that as public debt surpasses about 80 percent of GDP, it becomes a drag on growth, because it raises debt servicing costs and uncertainty about the future tax burden; it increases sovereign risk premia; and it reduces the room available for counter-cyclical policy."
In effect, the general manager of the Bank for International Settlements is warning that the radical steps undertaken by central banks during the global crisis can do no more than buy time for the politicians to get their act together and craft sound economic and fiscal policies that are the underpinnings of sustained growth. To believe that central banks can or should continue their artificial pump priming indefinitely as a substitute for true economic reforms is to evade understanding of the scope and limits of what central banks are capable of.
Caruana offered the following summation:
"Borrowed time should be used to restore the foundations of solid long-term growth. This includes ending the dependence on debt; improving economic flexibility to strengthen productivity growth; completing regulatory reform; and recognizing the limits of what central banks can and should do."
Regrettably, none of the steps outlined by the BIS general manager have been implemented in any major advanced economy impacted by the global economic and financial crisis. It is likely that the limits of what central banks can accomplish will only be realized when the next major financial crisis arises.