WASHINGTON Central banks got it right when they saved the world economy, but their unprecedented actions risk disruptive cross-border spillovers and potentially heavy losses when the time comes to exit, the IMF said on Thursday.
In the most detailed survey so far of the dramatic measures undertaken to counter the 2007-2009 global financial crisis, International Monetary Fund staff repeated earlier assessments that the steps had worked, but face diminishing returns.
However, in new work undertaken to answer a question that remains controversial in many countries, including the United States where the Federal Reserve was in the eye of the storm, it also outlined scenarios where losses on exit could be severe.
Central bankers have pumped trillions of dollars, euro and yen into the global economy through bond buying campaigns to spur growth after interest rates were slashed close to zero, prompting critics to warn of future inflation.
But the IMF reserved its toughest language for politicians who fail to make use of the opportunity won by ultra-easy policy to undertake long-overdue reforms.
"A key concern is that monetary policy is called on to do too much, and that the breathing space it offers is not used to engage in needed fiscal, structural, and financial sector reforms," the IMF said in the report.
"These reforms are essential to ensuring macroeconomic stability and entrenching the recovery, eventually allowing for the unwinding of unconventional monetary policies," it said.
Central bank critics claim that keeping rates ultra-low for more than four years risks future inflation and fanning the next asset bubble, while exposing the institutions to steep losses, and the IMF found evidence to support elements of that claim.
It looked at the Fed, Bank of Japan and Bank of England and found all three would face balance sheet losses if they had to sell bonds in order to quickly shrink their balance sheets, or pay interest on excess reserves held by private banks to prevent this flooding into credit markets and fanning a bubble.
The Fed has tripled its balance sheet to over $3 trillion through three waves of bond buying and the Bank of Japan surprised markets last month declaring it would drive inflation up to 2 percent through asset purchases.
The Bank of England has bought bonds worth 375 billion pounds ($575 billion) so far but opted to not increase that amount at this stage when it reviewed policy on May 9.
Under the worst-case scenario that the IMF examined, losses could top 7 percent of GDP for the BOJ, nearly 6 percent of GDP for the BOE, and more than 4 percent at the Fed. But the IMF stressed losses were mainly a political problem and would not hurt the real economy or prevent the central bank from doing its job.
"Absent actual or feared political interference, however, central bank losses and the size of balance sheets should not constrain the implementation of monetary policy," it said.
Another source of danger lies in the cross-border spillovers of ultra-easy monetary policies that encourage investors to pour capital into higher-yielding emerging markets.
IMF staff acknowledged the risk, but said that so far there was no clear evidence that the costs from spillovers outweighed the benefits of stronger global growth resulting from actions by central banks in advanced economies.
"Thus far, capital flows to emerging markets have been ample, but not alarming," the report noted. "While a number of factors such as high commodity prices and growth imply that these flows could be structural, legitimate concerns about a sudden change in global market sentiment remain."
(Reporting By Alister Bull; Editing by Andrea Ricci and Leslie Gevirtz)