Interview with Claudio Borio, Head of the Monetary and Economic Department, Bank for International Settlements (BIS)
"The expectations on central banks are simply too great"
Mr Borio, how worried are you about the global economy at the moment? Do you see a risk of a global recession, or are we experiencing a stabilisation that could be followed by a recovery?
We are witnessing a kind of tug of war between manufacturing, which is suffering greatly from global trade tensions, and services, which continue to hold up quite well. Global investment is quite weak, but consumption is quite strong. Consumption is benefiting from the continuing good labour market conditions in many places.
And which sector will win this tug of war?
Historically, there has been no clear pattern of manufacturing succeeding in pulling the services sector along, or vice versa. There are some signals that manufacturing weakness may be infecting services. But it is early days: as I just mentioned, services are holding up quite well. It is very hard to make a prediction. That said, globally, services outweigh manufacturing, even if the extent is less pronounced in some countries, such as Germany.
So you are rather confident and do not fear a global recession?
We do not make forecasts at the BIS, and assessments are currently very uncertain. Our research suggests, however, that financial cycle proxies are a better indicator of recession risk than, for example, the yield curve – at least in many countries. If you look at these indicators worldwide, you don’t get a sense that a recession is imminent. There are clear vulnerabilities. But China is the only major economy where the financial cycle appears to have peaked or turned. The authorities there are fully aware of the risks involved, are addressing the problems and have more room for manoeuvre than elsewhere.
The central banks worldwide, above all the US Federal Reserve and the European Central Bank (ECB), reacted to the global growth slowdown with a complete turnaround in 2019 – from a cautious normalisation of monetary policy to a further significant easing. Was that appropriate or an overreaction?
Central banks have adopted a risk management approach. The indicators are not foolproof. They have missed recessions in the past. One should remain very cautious.
This risk management in monetary policy obviously involves weighing acting too late and doing too little against acting too early and doing too much. However, this entails risks that the BIS has always warned against.
If one is concerned that inflation expectations might become de-anchored and that the central bank will reach the effective lower bound on rates, this can justify acting quickly and aggressively. This is exactly what many central banks are doing. At the same time, however, there are also longer-term issues. Very loose monetary policy increases risk appetite. Very low interest rates for a very long time can weaken banks and other financial institutions. They may also misallocate capital and encourage further debt accumulation. These risks must also be taken into account, as we said in our latest Annual Economic Report. Central bankers are very aware of them.
Is that the case? Do you share the impression that central banks are more focused on the short than the long term?
Given central banks’ price stability objectives, monetary policy is strongly driven by concerns about inflation expectations and the interest rate floor. But let me make one more point: in some circles, there is a view that central banks are all powerful. In particular, there is a view that monetary policy could be the engine of sustainable growth. That is very dangerous. Central banks are not all powerful, and monetary policy cannot ensure sustainable growth. That is why we need a more balanced policy mix. For far too long, central banks have borne the burden of ensuring the global economic recovery. In addition, the room for manoeuvre for monetary policy is much smaller than it was before the crisis.
Have the central banks reached their limits?
Country differences aside, the room for manoeuvre is increasingly narrowing overall.
This is also why central banks and others have intensified their calls for a more active fiscal policy. Rightly so?
Monetary policy cannot do everything on its own, and its scope is increasingly limited. It is therefore natural that fiscal policy should offer a helping hand. What is crucial, however, is that this be done wisely. The sustainability of public finances must not be called into question. This also means that not all countries have room for manoeuvre. It is also about a growth-friendly fiscal policy. Well chosen and executed investment, for example, is generally preferable to current expenditures. It is not a question of fiscal policy per se, but of wise fiscal policy.
Some experts, including ex-central bankers, advocate greater cooperation or even coordination of monetary and fiscal policy. What do you think?
Monetary and fiscal policy have their own mandates and roles to play, and of course it helps if both march in the same direction: aiming to boost the economy and increase inflation if it is too low. However, the boundaries between monetary and fiscal policy must not disappear. That is why I do not believe in proposals such as “helicopter money” or the monetisation of fiscal deficits. Otherwise the risk of fiscal dominance, where public finances heavily constrain what central banks can do, would loom large.
Despite all the discussion about fiscal policy – would it not be appropriate to focus more on structural policy?
Absolutely! Structural policy is the only engine of sustainable growth. That is why developments since the financial crisis have been so disappointing. In the immediate aftermath, with their backs to the wall, many governments did implement structural reforms. However, OECD analyses show that this has de facto come to a standstill since 2011. A rethink is urgently needed.
Let us come back to monetary policy. The central banks also justify their course with the fact that inflation is below the 2% target that is widespread. Why is that so?
Nobody really knows the answer to that question. From our point of view, globalisation and technology have a major influence. For example, globalisation has weakened the pricing power of companies and the bargaining power of workers given the entry of relatively cheap labour. Technological progress has led to capital replacing labour. All this keeps downward pressure on inflation. Before the crisis, this acted as a tailwind. It allowed monetary policy to be more accommodative than it would otherwise have been. Post-crisis, however, this has become a headwind. Inflation is generally not moving towards target as central banks would like.
Some critics argue that there is no longer any connection between monetary expansion and inflation.
There is certainly a relationship. But the question is how strong it is. The Phillips curve, for instance ...
... which sees a direct relationship between the labour market and capacity utilisation, on the one hand, and inflation, on the other ...
... will surely continue to exist, even if it has changed. There must surely be a relationship between the utilisation of resources, such as labour, and inflation. It is difficult to say exactly when this point will be more clearly visible. But it’s also crucial to look at the global level. The weight of global forces relative to country-specific ones has tended to increase, especially if we include the role of technology.
But inflation is not “dead”, as some forecasters think?
Inflation may be dormant, but it would be a big mistake to declare it “dead”. Everyone should be aware that inflation may rise in the future – and that it may do so unexpectedly strongly. But the long-term picture is that we are living in a disinflationary world, not in an inflationary one.
In the fight against economic weakness and low inflation, central banks have taken unprecedented measures such as quantitative easing (QE) or negative interest rates. What is your conclusion on these measures?
These instruments can stimulate economic activity. However, the longer they are used and the further they are pushed, the more the cost-benefit balance may deteriorate. In that case, benefits decrease and collateral damage increases.
Has the point already been reached where the risks of loose monetary policy outweigh the benefits?
Each central bank must judge for itself.
Some critics even argue that negative interest rates could undermine the foundations of the financial system. Do you share this concern?
As mentioned before, they do weaken the financial system. Beyond that, their impact on activity depends also on psychology. How do people react to negative interest rates? Do they spend more or save more for old age? Do they find the extraordinary situation alarming? This can vary from country to country and over time. It is something that central banks need to monitor closely. When I say that the room for manoeuvre for monetary policy is narrowing, that is not in the technical sense. For instance – and to put it bluntly – a central bank could, theoretically, buy up all the assets in an economy. The real question, however, is what longer-term consequences substantially extending purchases will have and how effective it is to loosen monetary policy much further. Monetary policy has limits.
How long can central banks stick to zero and negative interest rates and QE before they themselves become a stability risk?
As I said, low interest rates encourage people to take on higher risks. The indicators of the financial cycle are not yet sounding the alarm. But there are vulnerabilities – for example, in the corporate sector, in the market for leveraged loans or as a result of the high debt globally. All this can exacerbate a downturn.
The International Monetary Fund warns against a “bubble” in bond markets. In fact, government and corporate bonds worth $17 trillion are yielding below 0%. How worried are you about that?
It’s difficult to talk about bubbles in bond markets. But if investors buy bonds only because they think they can resell them, not least to central banks, before it’s too late, it would not be a wise strategy and it would have elements of a “bubble”. More important from my point of view is to analyse what the long-term consequences of such low rates for so long are.
So you are not afraid of a rapid trend reversal – of a bursting?
Of course, there may be a sudden snapback at some point. Many investors have adjusted their portfolios on the assumption that interest rates will remain very low for a very long time. If inflation picks up at some point and the central banks react, many asset prices would experience strong, even turbulent, movements.
Is there even a threat of a new financial crisis in the coming years?
I don’t see any risk of a global financial crisis in the next few years. Prudential regulation has done a lot. But that doesn’t mean that there can’t be phases of financial stress. This is especially true in countries where the financial cycle has turned and/or the banking system is not strong enough. Fortunately, a crisis like the one in 2008 and 2009 happens only rarely.
When it comes to risks in the financial system, central banks refer to macroprudential supervision. Don’t they make it a little too easy for themselves?
Here too, a balanced policy mix is needed. At the BIS, we advocate a “framework for macro-financial stability”. We cannot place the entire burden on monetary policy, nor can we shift all the responsibility onto macro-prudential policy. Macroprudential policy alone cannot do it. Monetary policy should also take into account financial stability considerations.
This puts us in the midst of the discussion on a review of monetary policy frameworks. The Fed is currently putting its actions to the test, and the ECB with new President Christine Lagarde should follow soon. Do you think this is right?
Yes, this is a good time for such a review. In general, if you are going to do one, it should be a 360° review.
Let us begin with the mandates. Many central banks are primarily committed to price stability. Is that still up to date?
As far as the mandate is concerned, it can be dangerous to put it up for discussion. Even if a central bank initially had a thoughtful and sensible proposal for a change, one would never know what the result would be once the political process takes over. In my view, the formal mandate is often less important than the conceptual framework a central bank uses to understand how an economy works.
What exactly do you mean?
Take the example of financial stability. Even if the mandate of monetary policy is price stability, a central bank will take financial stability into account to the extent that it thinks financial stability influences macroeconomic and hence price stability. The greater the influence, the greater the weight of this consideration. In any case, the evidence suggests that financial boom-bust cycles have very damaging long-term consequences for sustainable growth.
In view of the inflation target, which is often 2%, you advocate more flexibility. What does that mean? Would you be in favour of a tolerance band for inflation instead of such a point target?
Such a tolerance band has advantages and disadvantages. However, flexibility can be achieved in many ways. The most important thing, in my view, is to be flexible with respect to the monetary policy horizon, ie the period within which the inflation target is to be achieved. If inflation is below the target and you think that there are good, positive forces behind it – such as technology and globalisation – then you can afford to accept inflation shortfalls for longer. You do not have to take countermeasures under all circumstances and by all means. The deviation of inflation from the target is not a sufficient guide for monetary policy. What matters is what causes this deviation and the broader economic context.
So the level of the inflation target is also less decisive? Some experts argue for lowering the 2% target, others for an increase.
You can discuss different numbers, and that can vary from country to country. But one thing is clear: a relatively low target is important. It is good to have price stability.
Do the global disinflationary trends support a lowering of the 2% target?
If countries want to lower their targets, they can, and some indeed have. Once again, it is crucial to have sufficient flexibility. But it is also important to dispel the idea that central banks can fine-tune inflation. Experience indicates that fine-tuning is not possible, not least when inflation is so low.
Do you see a danger that the era of independent central banks could come to an end – given the criticism from politicians or the demands for more cooperation with fiscal policy?
I see some of the tensions with politicians less as a threat to independence than as proof that independence is working. But of course independence cannot be taken for granted. It must be earned, retaining trust and legitimacy in the eyes of the public. From my point of view, there is no doubt about the importance of independence. When defending it, one must address the growing gap between what central banks are expected to deliver and what they can actually deliver. I’m very worried about this expectations gap. The expectations on central banks are simply too great.
Isn’t this “expectations gap” now threatening to widen if central banks see themselves as important players and monetary policy an instrument in the fight against climate change? Not least, new ECB President Lagarde seems to be moving strongly in this direction.
Monetary policy has a clear mandate. Central banks do what they think is best to fulfil that mandate. For example, if they are already buying private securities as part of monetary policy, they might end up buying more green bonds. For that, it would help to have clear standards of what is green or not. Fighting climate change is primarily the job of politicians.
So you are not afraid that monetary policy will continue to be overburdened with new demands such as protecting the environment?
The decisive factor is the mandate. The mandate remains the lodestar for central bank actions.
Another issue that is currently a hot topic for central banks is Facebook’s planned digital currency, Libra. How big do you think Libra’s risks are?
Libra has put the spotlight on the heavy cost of cross-border transactions, giving it the attention it deserves. The existing payment and settlement systems need to be improved and brought up to date. But of course a global digital currency could have risks for financial stability and consequences for monetary policy. The right approach is to build on the existing payments infrastructure, with central banks at its core. Central banks have to step up to the plate, and they have begun to do so. Through the new Innovation Hub, the BIS is playing an active part.
Can Libra even threaten the state money monopoly?
The prospect is unrealistic, more like science fiction. The decisive factor determining people’s trust in money is who secures the monetary arrangements. Historically, private currencies have fallen well short of their promise.
The interview was conducted by Mark Schrörs.
Börsen-Zeitung, 21st of November 2019
Claudio Borio is Head of the Monetary and Economic Department, Bank for International Settlements (BIS)