The central bankers' bank (the Bank for International Settlements) is not very impressed with its members' efforts over the past year. Readers may remember that the BIS Report last year explicitly warned of the problems that were about to occur in world financial markets. This year's Report expresses its disappointment about what central banks did in response:
• Last year, it warned of a possible rise in global inflation. This year, it calls inflation 'a clear and present threat'. And the BIS worries that 'real policy rates in most countries are very low'.
• Last July, it worried that the US slowdown would prove greater than expected. This year, it forecasts 'a deeper and more protracted global downturn than the consensus view seems to expect'.
• Last July, it worried about exchange rate volatility and that the US$ might fall further than then expected. This year it notes that 'volatility picked up sharply, and was associated with a faster rate of decline of the US$'.
• Last July, it pointed out that asset markets were 'priced to perfection' and any shock might have unwelcome consequences. This year, it notes that markets have suffered from 'widespread financial stress'.
The BIS does not pull its punches about what needs to be done now. It regards inflation as the major threat to the global economy, and is prepared to temporarily sacrifice growth in order to bring it back under control. The BIS therefore calls for 'a global bias towards monetary tightening'.
It also advocates holding interest rates high until 'the global economy slows sharply and inflationary pressures recede'. Equally, it wants governments to prioritise measures to 'deal with losses and debt overhang problems as a high priority', rather than adding to current problems via 'expansionary fiscal policies'.
The BIS concludes that the world now faces 'the difficult task of damage control'. If ithe BIS analysis is right, and its track record speaks for itself, then the world faces a stark choice. On the one hand, the BIS is proposing a period of much higher interest rates, even at the risk of a short-term 'hard landing'. On the other, there is the prospect of a continuation of present central bank policies, which may result in an extended period of rising inflation and slower growth.
CFO's would be prudent to include both of these possibie scenarios in their preparations for the 2009 Budget cycle.