BIS seeks higher world interest rates

By Chris Giles
Financial Times, London
Monday, June 30, 2008

http://www.ft.com/cms/s/0/f6cd0278-46c3-11dd-876a-0000779fd2ac.html

Global inflation is a "clear and present threat" to a world economy that needs higher interest rates and a new framework to deal with future credit and asset bubbles, the Bank for International Settlements said on Monday.

In a hard-hitting annual report the organisation, which oversees central banks and banking regulators, warned that the current financial market turmoil still threatened a severe slowdown as banks and individuals struggled to reduce debts. The interaction between rising inflation and the credit crisis "does appear to point to a deeper and more protracted global downturn than the consensus view seems to expect," the report argued.

Often known as "the central bankers' bank," the BIS has warned repeatedly of the dangers in the build-up of credit and low real interest rates of the past decade.

In what reads as a valedictory report, Malcolm Knight, its outgoing general manager, and William White, its outgoing chief economist, concluded: "It is not fanciful, surely, to suggest that these low levels of interest rates might inadvertently have encouraged imprudent borrowing, as well as the eventual resurgence of inflation."

The report criticised the focus on what has been different in the recent credit crisis and urged people to look at "what is the same" -- excessive credit growth and the tendency of the financial system to amplify good times and bad.

The immediate problem that required rapid action, the BIS said, was rising inflation. This "should imply a bias of global policy towards being much less accommodating."

But the BIS was not about to criticise the Federal Reserve directly for its large cuts in interest rates. It insisted that with the twin threats of slowdown and inflation, there was not a "one size fits all" policy for all countries and higher interest rates were needed on average in the world.

If a deep downturn emerges, fiscal action might be required, the report said, because "the effectiveness of lowering of policy rates might be significantly reduced in the aftermath of a credit-induced spending boom." But the report cautioned that many government budgets were too weak to be much help.

"Perhaps the principal conclusion to be drawn from today's policy challenges is that it would have been better to avoid a build-up of credit excesses in the first place," the report concluded.

The BIS repeated its long-standing view that policymakers should "lean against the wind" with all tools at their disposal -- interest rates and regulations -- to reduce the size of credit and asset bubbles.

In pushing the case for counter-cyclical monetary and regulatory policy very strongly, the BIS is advocating the stance at a time when many central banks are starting to look at such ideas more favourably.

The traditional view of the Federal Reserve, for example, had been that it is too difficult to identify a bubble and too painful to burst it, and it is better to mop up the mess once it deflates. But thinking at the Fed is developing.

The BIS concedes: "Not everyone accepts the hypothesis that excessive credit growth is the root of the problem." But it adds: "While hopefully it will not came to that, if the costs of the current turmoil continue to mount and policy measures prove largely ineffective, such beliefs are more likely to be re-evaluated."

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