Bubbles Worry Central Bankers

Soda_bubbles_macroAfter years of QE and other loose monetary policies, central banks are starting to get jitters about the effects of their policies.

An organization representing the world’s main central banks warned Sunday that dangerous new asset bubbles were forming even before the global economy had finished recovering from the last round of financial excess.

Investors, desperate to earn returns even as official interest rates are at or near record lows, have been driving up the prices of stocks and other assets with little regard for risk, the Bank for International Settlements in Basel, Switzerland, said in its annual report published Sunday.

It turns out that low interest rates do have a cost. And that cost is not just limited to increased risk taking. According to Jaime Caruana, the general manager of the BIS, “during the boom, resources were misallocated on a huge scale… [I]t will take time to move them to new and more productive uses.”

The time it takes to move these resources to where they are valued most highly is being disrupted by central bank monetary policy. Consider the size of the financial sector, or the amount of leverage in the economy. Few would say that there either of these factors were not something that contributed to the crisis in 2008. By foisting low interest rates onto their economies, central banks have slowed or stopped altogether the deleveraging and shrinking of the financial sectors, none of the adjustments necessary for recovery.

Part of the problem is that central bankers don’t understand what interest rates are.

The B.I.S. also had harsh words for corporations, which it said were not taking advantage of booming stock markets to step up investment. That is one reason that gains in productivity — the foundation of sustained economic growth — have slowed in most advanced economies, according to the report. “Despite the euphoria in financial markets, investment remains weak,” it said. “Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions.”

These central bankers are stuck in a mindset of “hydraulic Keynesianism” where prices are supposed to be manipulable to get the desired result. Never mind that corporations are currently trying to reduce risk exposure, and that low interest rates are hindering, not helping them do this.

(Originally posted at Mises Canada.)

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