BIS: a more balanced policy mix for a sustainable economic growth

Could the huge amount of monetary base, of liquidity, provided by central banks, become a source of tension? «The monetary base is not a particularly useful concept to understand what happens to the money supply. The key anchor of our monetary system is the interest rate. I don’t think it would matter so much how large the monetary base is, in terms of the impact on the economic activity, what is more important is how much and what the central bank buys as a counterpart to the increase in the monetary base. «At the end of the day, it is the combination of large central banks’ asset purchases and very low, sometimes negative, interest rates for very long that contributes to some of the vulnerabilities we have seen - vulnerabilities in terms of risk-taking, of increases in debt and of low bank profitability. «Obviously, even if the short-run impact of monetary policy on banks is positive because it can boost economic activity and asset prices, these effects are temporary. In the longer-term, what stays is lower interest margins. Slowly over time, the longer interest rates remain low, the more difficult it is for banks. Just look at Japan. That's one of the reasons, not the only reason, why banks are not as profitable as we would like.

What can the banking system do to become more profitable in this situation? «It is important that banks get their act together. An environment in which interest rates are low and are likely to stay low for a long time, in which there is excess capacity in some jurisdictions and in which in some cases legacy problems - bad debts – have not been eliminated, is an environment that is likely to give rise to growing challenges over time. Addressing them requires finding the right business models, taking advantage of new technologies, succeeding in cutting costs and consolidating where there is such a need. In the Annual Economic Report, we also have one chapter on the Big Techs - another looming threat for banks that is providing yet another reason for them to adjust. «Of course, also the authorities have a role to play: they can encourage banks to sort out their bad loans; to the extent that there is excess capacity in the sector, they can make sure that mechanisms for an orderly exit are in place; and they can facilitate cross-border mergers, without trying to create national champions. Moreover, going back to the structural measures, it is important to make labour markets more flexible so that banks can adjust more easily».

According to some economists, a struggling banking sector and an accommodative monetary policy for a long time could create zombie firms, companies that in a ‘normal' environment would not be able to survive. It is really a problem? And how can we handle it? «In the Report, we use a definition of zombie firms which is narrower than that of the OECD, and on that we found that the number of listed companies in the sample of countries that we look at is about 6%. So, one should not overemphasise the issue. «But our figures do not include non-listed companies. And zombie firms are not a problem just for themselves, they are a problem for the rest of the economy because they absorb resources that could be used more productively by other companies. Therefore, directly and indirectly, they have an impact on productivity. They might even put downward pressure on inflation, as firms that are kept alive by generous funding undercut rivals – an aspect worth investigating. «The very accommodative monetary policy is one factor contributing to the existence of zombie firms; bank balance sheets saddled by non-performing loans is another – and the two are not unrelated. Ultimately, of course, what you would like to do is to get higher sustainable growth, and that basically goes back to our call for a more balanced policy mix».

It seems that a prolonged accommodative monetary policy has a lot of side effects. When will the monetary policy go back to “normality”? «You need two conditions. An obvious one is that the economy does well. An even more important one, given central bank mandates, is higher inflation, and this is really the billion dollar question. We have seen that despite the fact that economies have been operating very close to potential – and in some cases even beyond standard estimates of potential --inflation has remained subdued. For a long time, this was because wages were very sluggish. And once wages started to increase at a more solid pace, it was the turn of prices not to adjust. Firms have been absorbing the increase in wages by cutting other costs or by squeezing profit margins. «This cannot go on forever. The so-called Phillips curve is not completely dead: it is dormant. At some point it will wake up, but it could take quite some time. To me, the biggest question we need to pose ourselves is what is driving inflation? More specifically, to what extent some of the driving forces are not so much cyclical, but rather more structural and longer term? «At the BIS, we have been stressing the role of two forces. One is globalisation, which is still playing itself out, partly by depriving labour of its bargaining power and firms of their pricing power. The other force is technology, which operates in a similar way and whose role is likely growing. These are big questions that we need to answer before understanding what the right monetary policy framework should be and how to adjust or refine current ones».

Globalisation and technology are two structural phenomena. Is it correct to use monetary policy, a typical tool to manage aggregate demand, to minimise their effects? «Central banks are trying to understand how much low inflation is an effect of globalisation or technology and how much it is the effect of the weakness of demand. In order to respond appropriately, clearly you need to get a sense of which of these two forces is at play. This is because they are benign forces: in one way or another they are engines of growth. Thus, to the extent that you regard these forces as important, then you can afford to be more tolerant of shortfalls of inflation from strict objectives, to allow more time to get inflation back to target. In fact, some central banks have been moving in that direction, in Norway, Australia, Korea and Thailand, for example. But these are not the big central banks».

Source: Il Sole 24 Ore

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