Crisis-fighting central banks are out of ammo

The Bank for International Settlements (BIS) is the central banks' central bank: it provides banking services to the world's major central banks, and tries to promote "international and monetary financial co-operation". But it's not afraid to criticise central banks and was "one of the very few international bodies to come anywhere close to predicting the [global financial] crisis", says Jeremy Warner on telegraph.co.uk. So its latest annual report is worth highlighting.

The BIS says that central banks won't be able to fight a future crisis, because they have already used up all their ammunition by slashing interest rates to unprecedented lows. Central banks have painted themselves into a corner by repeatedly using lower interest rates to prop up economies.

These low rates in turn have fuelled booms and busts, which have been tackled by even looser monetary policy. Rates have never been lifted back as high as they should have been, with the result that central banks have run out of scope for combating future crises through traditional tools.

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Indeed, rather than reflecting economic weakness, central banks' actions "may in part have contributed to it by fuelling costly financial booms and busts and delaying adjustment", says Claudio Borio, head of the BIS's monetary and economic department. "The result is too much debt, too little growth and too low interest rates. In short, low rates beget low rates."

The BIS also points out that a nasty side effect of low rates is poor productivity. The potential return on investment falls with interest rates. Companies are thus reluctant to plough money into new products or equipment, undermining business investment and overall productivity. Another reason productivity has suffered is that economies have got too used to relying on debt to muddle through and have put off "badly needed" structural reforms.

Ideally, central banks should be putting up interest rates now that growth is returning, with the fall in oil prices providing a tailwind, according to the BIS. Unfortunately, however, as the body noted last year, low interest rates have helped ensure that the global economy is carrying even more debt than in the run-up to the last crisis.

So central banks are nervous about increasing the cost of money.For years now, they have been too keen to take the easy way out with easy money, adding fuel to unsustainable booms and encouraging people to put off tackling their debt. Now they look stuck.