by Don Alexander, MBA
Associate, RSD Solutions Inc.
The global economy, after five years, has yet to overcome the legacies of the financial crisis to achieve balanced, self-sustaining growth. In different ways, vicious cycles are hindering the transition for both the advanced and emerging market economies as noted in the first chapter of the 2011 BIS Annual Report.
Moving the global economy to a path of balanced, self-sustaining growth remains a difficult and unfinished task. However, a number of interacting structural weaknesses are hindering the reforms required. Investors and politicians hoping for quick fixes will continue to be disappointed – there are none. Central banks, already overburdened, cannot repair all these weaknesses – consumer debt reduction, stimulate investment and job creation while creating an attractive investment environment.
A look at the global economy suggest that there are three areas for adjustment: the financial sector needs to recognize losses and recapitalize; governments must put fiscal trajectories on a sustainable path; and households and firms need to deleverage. As things stand, each sector’s burdens and efforts to adjust are worsening the position of the other two. All of these linkages are creating a variety of vicious cycles.
Central banks find themselves in the epicenter, pushed to contain the damage: expected to fund the financial sector while maintaining low interest rates to ease the strains on fiscal authorities, households and firms. This pressure puts the central banks’ price stability objective, their credibility and, ultimately, their independence at risk.
Taming the vicious cycles, and reducing pressure on central banks, is critical. This goal requires cleaning up and strengthening banks at the same time as containing the riskiness of the financial sector. Bank balance sheets must accurately reflect the value of assets; while making progress on this score more rapid movement is required. As they do, policymakers must ensure speedy recapitalization, see that banks build capital buffers as conditions improve, authorities must implement agreed financial reforms, and extend them to shadow banking activities.
In the euro area, the effects of the vicious cycles have reached an advanced stage that reflects not only weaknesses seen elsewhere but also the incomplete nature of financial integration in the currency union. Europe can overcome this crisis if it can address certain issues: structural adjustment, fiscal consolidation and bank recapitalization; and unify the framework for bank regulation, supervision, deposit insurance and resolution. That approach will decisively break the damaging feedback between weak sovereigns and weak banks, delivering the financial stability required that will allow time for further development of the euro area’s institutional framework.
Overall, in Europe and elsewhere, the revitalization of banks and the moderation of the financial industry will end their destructive interaction with the other sectors and clear the way for the next steps – fiscal consolidation and the deleveraging of the private non-financial parts of the economy. Only then, when balance sheets across all sectors are repaired, can we hope to move back to a balanced growth path? Only then will virtuous cycles replace the vicious ones now gripping the global economy.
Otherwise, the job of the risk manager will prove very difficult.
For more on this, follow the link: http://www.bis.org/press/p120624.htm
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