© picture alliance / Rolf Haid

The Bank for International Settlements (BIS) has cautioned against expecting too much from global economic growth. Writing in its latest Annual Report, the "central banks' central bank", as it is known, notes that growth rates are not far away from historical averages. "As empirical evidence tells us, output following financial crises may regain its previous long-term growth rate," Claudio Borio, Head of the Monetary and Economic Department at the BIS, explained when the report was unveiled. "But it is unrealistic to expect that it will return to its pre-crisis path," he warned. The BIS writes of the urgent need to rebalance policy in order to shift global economic activity to a more robust, balanced and sustainable expansion.

"Risky trinity"

However, the BIS has identified what it terms a "risky trinity" that bears watching. Productivity growth is unusually low; global debt levels are historically high, raising financial stability risks; and room for policy manoeuvre is remarkably narrow, leaving the global economy highly exposed. A highly visible sign of this discomfort, the BIS writes, has been the exceptionally and persistently low interest rates. "The global economy cannot afford to rely any longer on the debt-fuelled growth model that has brought it to the current juncture," the Annual Report notes.

The BIS believes that prudential, fiscal and, above all, structural policies must now come to the fore, claiming that monetary policy has been overburdened for far too long. Measures should be embedded in longer-term efforts to put in place an effective macro-financial stability framework better able to address the costly ups and downs of the financial cycle, the Annual Report states. "We badly need policies that we will not once again regret when the future becomes today," Borio cautions.

Debt unduly incentivised

In the fiscal policy space, the BIS proposes a raft of measures, including improving the quality of public spending. Sovereigns, it writes, should shift the balance away from current transfers towards investment in both physical and human capital. The BIS also calls for the current composition of taxes and subsidies to be adjusted so that it no longer unduly incentivises debt. "The most important contribution to crisis prevention may come from removing tax provisions that unduly incentivise debt over equity, leading to too much leverage and greater financial fragility," the report explains.

The priority for prudential policy, the BIS continues, is to finalise banks' balance sheet repair, which is still lagging in a number of crisis-hit jurisdictions. It remarks that ensuring that banks have pristine balance sheets and are well capitalised is the best way to relieve pressure on other policies and improve their traction. Moreover, restoring the banking sector's long-term profitability also calls for eliminating excess capacity, a process for which tight supervision can be the catalyst.

The BIS sees a need for macroprudential tools and intensified supervisory vigilance in countries not affected by the crisis. These measures, it writes, are key to quickly identifying and resolving any deterioration in the quality of the assets held in banks' balance sheets.

The BIS sees a particularly strong need for reform in the field of structural policies. "Unfortunately, in this area the gap between needs and achievements is especially large," the authors write, noting that the importance of structural policies has been clearly recognised – witness their salience in G20 deliberations. Yet the record on implementation so far has been very disappointing, with countries falling far short of their plans and aspirations. "Redoubling efforts is essential," the BIS cautions.

Stretching the boundaries of the unthinkable

A sense of discomfort has emerged, Mr Borio explains, from the further decline in interest rates from already persistently and exceptionally low levels. And the amount of global sovereign debt trading at negative yields has soared to close to $9 trillion in mid-June 2016. "We continue to stretch the boundaries of the unthinkable," Mr Borio stressed.

BIS economists also used the Annual Report to address concerns over the diminishing effectiveness of monetary policy, shedding light on the growing prominence of external transmission channels such as exchange rates.

In the view of the BIS, monetary policy should take account of financial stability to complement its current focus on inflation. Outlining the BIS's position, Mr Borio said: "For monetary policy to yield the hoped-for benefits, it would need to take systematic account of the financial cycle, during both booms and busts, so as to keep the financial side of the economy on an even keel." In his eyes, "monetary and financial stability are two sides of the same coin."