Bankers bang their drum on governments borrowing less
The BIS suggests that macroeconomic objectives should be tougher. It is not just monetary policy which has to be disciplined: fiscal policy has to be more disciplined too
Tuesday 10 June 1997
The view is apolitical in the sense that it is above national party politics, but naturally it reflects central bankers' values which, unlike those of national politicians, tend to be pretty universal. But since those values seem to be in the ascendant everywhere - look at the way the Bundesbank won its "gold war", or the growing power of the Bank of England - the views deserve to be taken seriously even by people who do not share the values behind them.
The core theme this year, as one might expect, is the sustained process of disinflation that continues around the world. We tend here to think of this principally as something which is happening in the developed countries, for these are the figures we see published in our media, but the BIS very properly points out that some of the most remarkable reductions in inflation have occurred in the developing world. The globalisation of the world economy has its impact on developing countries as much as developed, in some cases more so.
The financial markets are now remarkably confident that the trend towards lower inflation will be sustained. Is the BIS so confident? Yes and no. Yes, it acknowledges that many of the forces which have pushed inflation down will continue to operate: rapid technical progress in electronics; globalisation itself; market liberalisation; retrenchment by governments correcting earlier spending excesses; and very high unemployment, often concealed. But it wonders whether the market is right in this conviction; or rather, while the market is probably right, whether it adequately allows for the risk that it might be wrong.
One particular area for misjudgement might occur when inflation expressed in terms of current prices remains low, but inflation in terms of assets prices soars. That is precisely what has been happening throughout the developed world, with the sole exception of Japan. As the BIS rather primly points out "swings of sentiment in financial markets are by no means new, but there may be particular problems of interpretation" of this phenomenon.
I suppose the question that the BIS is posing here is whether the markets' current mood is really the "irrational exuberance" feared by the Fed's Alan Greenspan or whether it is more securely grounded. Since we cannot know before the event, there is certainly a case for designing financial structures which are robust enough to withstand unpleasant shocks.
At one level this may simply mean tougher prudential regulation - one very interesting idea floated is that central banks maybe should have less discretion in fixing monetary policy but able to impose tighter banking controls. Translated into UK practice, that might mean less independence for the Bank on interest rates, or rather less discretion but more explicit targets, and tougher powers for the newly expanded SIB. But the BIS goes beyond this and suggests that general macroeconomic objectives should be tougher. It is not just monetary policy which has to be disciplined: fiscal policy has to be more disciplined too. For example, "Simply stabilising government debt/GDP ratios must be seen as inadequate, since at some time there will inevitably be another recession which will push them back up."
It is useful to remind policy-makers that there will be another recession. The graph shows what has happened to the debt/GDP ratios for the Group of Seven countries since 1990, the period which spans the last recession, but also several years of recovery. In every one of those countries, the ratio has risen. In other words, governments have failed to use the opportunity of the expansion to claw back the ground they lost.
The BIS has no precise blueprint for what should be done, but the experience of the redisciplining of monetary policy which took place during the 1980s shows that setting explicit targets does seem to be a useful guide to action. Arguably one of the lasting legacies of the Maastricht process, whatever happens to the plan for a single currency, will be to focus attention on the unsustainable level of public sector deficits. If, for example, the UK government had been forced to make its long-term plans for the growth of public debt explicit - that it would accept that debt levels might rise from 35 per cent of GDP to 56 per cent, there would have been much greater opposition to these plans. The BIS does not say it in so many words, but it may well be that the next decade will see a global redisciplining of fiscal policy, analogous to the global redisciplining of monetary policy which has just taken place.
The other area where the BIS view ought to be interesting is the plan for the single currency. Here, the reader will be sadly disappointed, for the BIS cannot speak its mind. There is a comment about the "euro" possibly taking over from the dollar as the main international currency and one noting that the markets have become more convinced that the plan would go ahead. But all this was written before the seismic events of the last three weeks, both in Germany and in France. Presumably the BIS would be hostile to a weak euro, and its views on fiscal discipline would point to scepticism about wide membership in the first phase. But remember that the BIS supplied the secretariat for all the work on the nascent European Central Bank, and its previous general manager became head of the European Monetary Institute. This, sadly, is one of those few areas where lips are sealed.
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