BIS Annual Report: The unsustainable has run its course and policymakers face the difficult task of damage control

The fundamental cause of today’s problems in the global economy is excessive and imprudent credit growth over a long period, says the Bank for International Settlements (BIS) in its 78th Annual Report released today. This always threatened two unwelcome outcomes: a rise in inflation and an accumulation of debt-related imbalances which would at some point prove to be unsustainable. In the event, both unwelcome phenomena are being experienced at the same time. Leaning against current inflationary pressures should imply a significantly less accommodating bias to global policy overall, even though this could create some short-run difficulties in some countries.

The BIS notes that the experience of the recent financial turmoil shows the need for a new macrofinancial stability framework to resist actively the inherent procyclicality of the financial system. This would require a primary focus on systemic issues and a much more countercyclical use of policy instruments. It also demands closer cooperation between the central banking and regulatory communities in trying to identify the build-up of systemic risks, deciding what to do to mitigate them, and agreeing in advance on steps that might be taken to manage periods of stress.  

Speaking today, BIS General Manager Malcolm Knight noted that “central banks face a difficult dilemma because inflation pressures have come to the surface just when downside risks to growth have increased”. Moreover, important aspects of central bank functions have come under consideration, including how they provide liquidity to banks and their role in financial system oversight. “The BIS looks forward to working closely with both central banks and regulators in developing better analytical frameworks for addressing these important questions,” Mr Knight added.

The 78th Annual Report was presented at the Bank’s Annual General Meeting held today in Basel, Switzerland, and chaired by Jean-Pierre Roth, Chairman of the BIS Board of Directors. Representatives from more than 130 central banks and international institutions attended.

The Bank’s balance sheet grew to SDR 311 billion (USD 511 billion) at end-March 2008. Official foreign currency reserves deposited with the BIS rose from SDR 222 billion to SDR 236 billion (USD 388 billion). This corresponds to a year-on-year increase of around 6%. The BIS’s 55 shareholding central banks will receive a dividend of SDR 265, around 4% higher than that for the previous financial year.