The vicious cycle: “central banks cut interest rates in an attempt to breathe new life into markets, which in turns creates incentives for more risk-taking, generating ever bigger crises that will require monetary stimulus over and over again”. Since the financial crisis, Bill White -economist at the Bank for International Settlements (BIS) - has been ringing the alarm bell to warn of the risks of this kind of economic policy. The results are here for all to see: “near-zero rates and massive asset purchase schemes by the big central banks”.
So how should policymakers deal with the fallout from a financial cycle that ended in a banking crisis such as this one? “When policy responses fail to take a long-term perspective, they run the risk of addressing the immediate problem at the cost of creating a bigger one down the road” believes the BIS.
But should fiscal and monetary policies be hardened at a time when the developed economies are growing again? Edward Harrison, on the other hand, writes on his “Credit Writedowns” blog that making deficit reduction a policy goal in itself can end in disaster bringing uncertainty and pro-cyclicality into the business cycle.
This brings us back to the starting point of the vicious cycle: what should policymakers do about debt excesses if they cannot adapt monetary and fiscal policies in order to address these?
The Economist offers some possible answers here.