IMF – Central Banks – So far, so good


The International Monetary Fund on Thursday said it has found no evidence that ultra-low interest rates and large-scale bond buying by central banks have led to excessive risk-taking by investors, but warned those problems may still be building.

In its Global Financial Stability Report, the IMF cautioned that the eventual exit from years of unprecedented monetary stimulus in advanced economies could pose threats to financial stability, as central banks start to raise interest rates and taper back their large asset portfolios.

While the IMF emphasized that central banks should not act yet to change the course of monetary policy, it urged them to stay alert to possible growing risks.

“So far, so good, but if the time that central banks have provided through their unconventional policies is not used productively…at some point we can expect another round of financial distress,” Laura Kodres, division chief in the IMF’s Monetary and Capital Markets Department, said.

Global finance leaders at meetings in Washington next week are expected to discuss how to avoid a serious threat to financial stability when major central banks start to unwind years of extraordinarily loose monetary policy

“With the economic recovery still fragile, the current policy stance is appropriate and there is no indication for now that exit from these policies are imminent,” Kodres said.

In the United States, several policy hawks of the Federal Reserve have warned that the U.S. central bank’s aggressive monetary stimulus could lay the ground for the next financial crisis.

The Fed is currently buying $85 billion a month in Treasury and mortgage-backed bonds to drive down borrowing costs and spur U.S. hiring. It says the program will continue until the outlook for the labor market brightens, although some Fed officials say they favor tapering the pace of the buying in coming months.

Japan last week applied a dose of shock therapy to its economy to try to end two decades of stagnation, pledging to inject $1.4 trillion into the economy in less than two years.

The IMF said its analysis found that aggressive stimulus had been effective in blunting the global 2007-09 financial crisis and the impact on banks, by keeping credit flowing. But it warned that exiting the monetary stimulus should be done gradually and be clearly communicated to financial markets.

The IMF said the main risks of an exit from loose monetary policies were tied to an unexpected or more-rapid-than-expected rise in interest rates, especially longer-term rates.

Emerging market countries worry that a rise in market rates in the United States could lure investment out of their economies after large capital inflows over the past several years.

Exiting the stimulus measures will mean that central banks start increasing interest rates, and they may also decide to sell some of the bonds they bought during the crisis, IMF economists said. If private investors, fearing a decline in bond prices, respond by selling bonds en masse, there could be a spike in interest rates and even a return to the panic of the financial crisis, they warned.

The IMF also said banks may face funding challenges as central banks drain excess reserves from financial markets to tighten credit conditions. Some banks will turn to the interbank market for funding, but could find the transition challenging. ( C) Reuters

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