23 June 2013
Originally forged to describe central banks' actions to prevent financial collapse, "whatever it takes" has become a rallying cry for them to continue their extraordinary policies. But we are past the height of the crisis, and the goal of policy today is to return to strong and sustainable growth. Authorities need to hasten structural reforms so that economic resources can more easily be used in the most productive manner. Households and firms have to complete the repair of their balance sheets. Governments must redouble their efforts to ensure the sustainability of their finances. And regulators have to adapt the rules to an increasingly interconnected and complex financial system and ensure that banks set aside sufficient capital to match the associated risks. Only forceful efforts at such repair and reform can return economies to strong and sustainable real growth.
During the past year, the global economic recovery continued to lose momentum. The moderation in growth reflected three broad trends: overall weaker but still solid output growth in emerging market economies; a continued tepid expansion of the US economy; and recession in the euro area. Central banks injected additional stimulus into the economy by cutting interest rates and by introducing policy innovations to further ease monetary conditions. These actions reduced downside risks and boosted financial markets. However, bank credit conditions continued to vary across countries, with strong credit growth in emerging market economies, easing credit conditions in the United States and tightening lending standards in the euro area. Although some economies have made progress in reducing private non-financial sector debt, incomplete balance sheet repair continues to slow growth and make economies vulnerable.
Productivity gains and employment in the major advanced economies have sagged in recent years, especially where pre-crisis growth was severely unbalanced. Before they can return to sustainable growth, these countries will need to reallocate labour and capital across sectors. Structural rigidities that hamper this process are likely to hold back the economy's productive potential. Both productivity and employment tend to be weaker in economies with rigid product markets than in ones with more flexible ones. Similarly, employment rates tend to be lower where labour markets are more rigid. Conversely, countries with flexible labour markets recover more quickly from severely imbalanced downturns. They also create more jobs. Reforms that enhance the flexibility of labour and product markets could be swiftly rewarded with improved growth and employment.
Despite progress in reducing deficits, public finances in many advanced economies remain unsustainable. Beyond the burden created by age-related expenditure, a potential rise in long-term interest rates from their ultra-low levels poses a risk to public finances in several countries. Many advanced economies therefore still need to increase their primary balances significantly to put debt on a safer, downward trajectory. Measures to curb future increases in pension and health care spending are key to the success of these efforts. Public finances in emerging market economies are in a relatively better position, but securing them for the future will require prudence.
Banks are making gradual progress in recovering from the crisis. Further solidifying the resilience of financial institutions requires that they maintain ample, high-quality capital buffers to absorb losses plus well managed liquidity buffers that will protect them against sudden collapses in market confidence. And it requires improvements in resolution regimes that will allow systemically important institutions to fail in an orderly way.
However, measuring and managing the risks of the increasingly international and intricate financial system continues to challenge the prudential framework. Here, the use of risk-sensitive metrics together with simple balance sheet gauges can play a key role in controlling financial system risk. In combination, these two types of measures are mutually reinforcing and thus generate more information on the riskiness of a bank than does either of them alone. Policies to structurally separate bank functions may also help reduce complexity at the level of the firm, but their impact on systemic stability and efficiency is an open question.
With monetary policies remaining very accommodative globally, central banks continue to borrow time for others to act. But the cost-benefit balance is inexorably becoming less and less favourable. Furthermore, the postponement of the inevitable exit from these policies poses increasing challenges for central banks. They must re-emphasise their stability-oriented framework for monetary policy, although in a way that takes greater account of both financial stability concerns and global policy spillovers.