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IMF: keep interest rates low or risk another crash

The International Monetary Fund concluded its annual meeting in Lima with a warning to central bankers that the world economy risks another crash unless they continue to support growth with low interest rates.

The Washington-based lender of last resort said in its final communiqué that uncertainty and financial market volatility have increased, and medium-term growth prospects have weakened.

“In many advanced economies, the main risk remains a decline of already low growth,” it said, and this needed to be supported with “continued accommodative monetary policies, and improved financial stability”.

The IMF’s managing director, Christine Lagarde, said there were risks of “spillovers” into volatile financial markets from central banks in the US and the UK increasing the cost of credit. The IMF has also urged Japan and the eurozone to maintain their plans to stimulate their ailing economies with an increase in quantitative easing.

But she urged policymakers in Japan and the eurozone to boost their economies with an expansion of lending banks and businesses via extra quantitative easing. But the policy of cheap credit and the $7 trillion of quantitative easing poured into the world economy since 2009 has become increasingly controversial.

A quartet of former central bank governors responded to the IMF’s message with a warning to current policymakers that they risked sowing the seeds of the next financial crisis by prolonging the period of ultra-low interest.

In a study launched in Lima to coincide with the IMF’s annual meeting, the G30 group of experts said keeping the cost of borrowing too low for too long was leading to a dangerous buildup in debt.

The study was written by four ex-central bank governors, including Jean-Claude Trichet, former president of the European Central Bank, and Axel Weber, previously president of the German Bundesbank, and now chairman of UBS.

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Jean Claude Trichet (left) and Axel Weber with German chancellor Angela Merkel in 2007.
Jean Claude Trichet (left) and Axel Weber with German chancellor Angela Merkel in 2007. Photograph: Alexander Heimann/Getty Images

Its publication comes at a time when both the ECB and the Bank of Japan are using money creation programmes to stimulate growth, and shortly after the US Federal Reserve responded to financial market turbulence in August by delaying an increase in interest rates. The report said the emergency action taken by central banks following the collapse of the investment bank, Lehman Brothers, in September 2008 had saved the world from a second great depression, but stressed that reliance on “unconventional policies might encourage excessive risk taking”.

It added: “The supportive actions by central banks can be useful, but there are serious risks involved if governments, parliaments, public authorities, and the private sector assume central bank policies can substitute for the structural and other policies they should take themselves. The principal risk is that excessive reliance on ever more central bank action could aggravate the underlying systemic problems and delay or prevent the necessary structural adjustments.”

Official interest rates have been at 0.5% in the UK since March 2009, the lowest level since the Bank of England was founded in 1694. Several European central banks have resorted to negative interest rates to fend off the threat of deflation, but Weber warned of the danger of side effects.

A demonstrator in Lima against the IMF and World Bank meetings holds a banner that says: ‘Against world capitalism. Long live those who fight.’
A demonstrator in Lima against the IMF and World Bank meetings holds a banner that says: ‘Against world capitalism. Long live those who fight.’ Photograph: Sebastian Castaneda/EPA

“The crisis laid bare that the pursuit of short-term price stability alone is not a panacea. Dangerous credit-driven imbalances can accumulate even when inflation is low and stable. Credit dynamics in the future will have to be monitored much more closely, since excessive debt may result in large imbalances and distortions,” Trichet said.

Trichet raised interest rates after the financial crash, only to lower them again when it became obvious the recovery was far from secure. He was roundly criticised at the time and IMF officials warned last week of the dangers for global market stability should a central bank be forced to cut rates after prematurely raising them.

He added: “The ultimate resolution of the crisis must be handled by governments, parliaments, public authorities as well as the private sector that should take advantage of the temporal opportunity offered by this extraordinary period of central bank policy.”

The report – “Fundamentals of central banking; the lessons of the crisis” – was co-written by Weber; Trichet; Jacob Frenkel, former governor of the Bank of Israel; and Arminio Fraga, former governor of the Bank of Brazil. Frenkel said structural reforms were needed to boost economies’ growth potential. “In the absence of such needed reforms, the unintended consequences of a prolonged period of extraordinarily loose policy are accumulating,” he added.


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