| BASEL, Switzerland, June 29
BASEL, Switzerland, June 29 Bids to stimulate
growth may spark only a temporary pick-up and then a long
stagnation because banks are not being pushed hard enough to fix
their underlying problems, the Bank for International
Settlements (BIS) said on Monday.
In its annual report, the BIS -- which acts as a forum for
the world's central banks -- said although authorities had tried
to arrest sharp declines in economic output, it was still an
open question whether the stimulus would lead to a sustained
"A major cause for concern is the limited progress in
addressing the underlying problems in the financial sector," the
As the financial crisis has deepened, central banks around
the world have slashed interest rates and poured extra liquidity
into markets, some by buying assets directly. [ID:nN22505328]
Governments have rushed to the aid of banks and pledged
extra public spending worth about 2 percent of economic output
at Group of 20 level this year, according to the International
Monetary Fund. [ID:nLT60041]
But the BIS said governments may not have acted quickly
enough to remove problem assets from the balance sheets of key
banks, instead focussing on guarantees and capital -- also
exposing taxpayers to potentially large losses.
Past experience showed that the key to recovery was to force
the banking system to take losses, dispose of non-performing
assets, eliminate excess capacity and build their capital base.
"These conditions are not being met. A significant risk is
therefore that the current stimulus will lead only to a
temporary pickup in growth, followed by protracted stagnation,"
the BIS said.
"The lack of progress threatens to prolong the crisis and
delay the recovery because a dysfunctional financial system
reduces the ability of monetary and fiscal actions to stimulate
The BIS, which has long warned of the dangers of asset price
rises, said the crisis also showed central banks must take a
more activist stance on asset and credit booms, leaning against
the wind rather than mopping up the damage afterwards.
"The financial crisis has shown that it is ultimately too
costly for central bankers to focus narrowly on inflation," it
said, noting that this preoccupation may have led some to make
"With the benefit of hindsight, one can see that
policymakers underappreciated the extent of the slowdown in
mid-2008 and the strength of the associated disinflationary
forces," the BIS said.
A major issue for the future was how to negotiate an exit
from the very expansionary policies now in place.
Increased public debt would weigh on budgets for years,
possibly pushing up real interest rates and crowding out private
investment, as well as undermining central bank asset buys.
"Getting public finances in order will therefore be the main
task of policymakers for years to come," the BIS said.
But the biggest risk was from a forced exit if markets lost
faith in governments' ability to repay debt, while pressure on
currencies might force central banks to run too-tight policy,
especially in small and open economies.
Tightening policy too early could thwart the recovery but
tightening too late might push up inflation, the BIS said,
noting that both central banks and governments were likely to
face strong political pressure to delay their exits.
"The short-term outlook is highly uncertain," the BIS said,
noting most forecasters saw a global economic contraction of 1-2
percent this year, with growth to recover in 2010 but remaining
well below trend.
"In the industrial countries, there are some signs that the
rapid pace of decline in spending witnessed since the fourth
quarter of 2008 has started to ease."
However, rising savings rates in industrialised nations
could also derail the recovery. "There is a risk that the
unusually synchronised downturn, combined with a possible jump
in household saving, could well aggravate disinflation pressures
over the next year or so," the BIS said.
Longer-term inflation expectations had remained stable,
providing some reassurance against deflation, but these could
also rise if consumers saw higher inflation as the only way to
erode the build-up of public debt.
Economic shakiness was not helped by a rise in currencies
for Japan and the euro zone, while the UK was benefitting from a
weaker pound. The rise of the U.S. dollar meant the exchange
rate had become more neutral in trade dynamics over the past
(Editing by Ruth Pitchford)