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Central banks find markets too optimistic

The central bank says that corporate bond markets and markets are too much ahead of the economic recovery.

It is a remarkable observation, but monetary policy can apparently also be too successful. This is hinted at by the Bank for International Settlements (BIS) in its annual report.


In particular, stock prices have disconnected from the weaker real economy.

Bank for International Payments Annual Report



“The success of the central banks in calming the markets and boosting confidence has led to some market intuberance,” says the BIS. In particular, stock prices and interest rate differentials between corporate and government bonds seem to have disconnected from the weaker real economy. This is more like a truce than a peace deal. “

Several economists have already underlined that the recent stock market rebound anticipates too much of an economic revival. But it is the first time that central bankers have so clearly conveyed that message. The BIS Board of Directors is home to the world’s leading central bankers, including Jerome Powell and Christine Lagarde.

Bankruptcies

Agustin Carstens, Director General of the Bank for International Settlements.
©Bloomberg


It is also noticeable that the BIS uses the word ‘exuberance’. It is reminiscent of the “irrational exuberance” warned by Alan Greenspan, the former president of the United States Central Bank, in December 1996.

The BIS underlines that the corona crisis is not over yet. After the phase of illiquidity, the phase of business insolvency and bankruptcy is now approaching. But the report notes that supporting corporate solvency is a task for fiscal policy, ie for governments.

The massive creation of money by the central banks will not lead to an increase in inflation for the time being. On the contrary, the fall in the oil price, the fall in consumption and the rise in savings have brought inflation down.

Monetary financing

The BIS stresses that there is no reason for complacency. She fears that the pandemic will lead to a sharp rise in government debt, a greater government grip on the economy and a reduction in globalization. In such an environment, companies and the production factor of labor will have more power to raise prices and wages.


Inflation will come back someday

Agustin Carstens

Director General Bank for International Settlements



“Inflation will come back someday,” warns Agustin Carstens, CEO of the BIS. “Due to the sharp rise in government debt, many voices will ask to keep interest rates artificially low and allow inflation as a tax to reduce the real value of debt. In order to maintain price stability, it is crucial that central banks remain independent to fulfill their mandates. ” The BIS fears tensions will arise between governments and central banks when inflation rises in a few years.

The BIS disagrees with recent pleas for monetary financing: central banks print money and transfer it to governments to pay the costs of the crisis. “Monetary financing can erode confidence in central banks. That would be a high cost to pursue a fleeting rise in short-term economic activity. During the recent crisis, the credibility of central banks gave them room to cross ‘red lines’ and thus stabilize the financial system and the economy. More than ever, it is necessary to keep fiscal policy on a sustainable path by restructuring in good time. ‘

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