Bank for International Settlement 82nd Annual Report

Overview of the economic chapters

Chapter I: Breaking the vicious cycles

The global economy 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.
After reviewing the past year’s economic developments (Chapter II), the
economic chapters address fundamental aspects of these vicious cycles:
unfinished structural adjustments (Chapter III), risks in the current stances of
monetary (Chapter IV) and fiscal policy (Chapter V), and the ongoing
challenges of financial reform (Chapter VI). Chapter I underscores the themes
and policy conclusions of the latter four chapters, and in a special section
examines them in the context of problems in Europe’s currency union.

Chapter II: The year in retrospect

In the advanced economies, the first months of 2011 seemed to offer the
beginnings of a self-sustaining recovery, a promise that turned out to be a false
dawn. The pattern appears to be repeating itself in 2012, with early signs of
strength gradually fading. The same set of hindrances has been at work in the
past two years. The crisis exposed the weak foundations of government
finances. With budgets in disarray, fiscal authorities have been forced to make
deep budget cuts at the same time as other sectors of the economy continue to
deleverage. In the euro area, the evolution of fiscal strains into a sovereign
debt crisis has severely undermined the confidence of investors and
consumers inside and outside the monetary union. Losses on sovereign bonds
have led many banks to cut lending, thereby further weakening the recovery.
Meanwhile, many emerging market economies have begun to see their
previously vigorous rates of economic activity drop off.

Chapter III: Rebalancing growth

Both advanced and emerging market economies face structural challenges.
Sectoral misallocations that built up during the boom, coupled with high levels
of household and corporate debt, continue to hobble growth in some advanced
economies. These countries must move to repair balance sheets as they
facilitate the rebalancing of resources across sectors. Meanwhile, a number of
other countries, including many emerging market economies, face the risk of
experiencing their own version of the recent boom and bust cycle. Their
rebalancing requires shifting from credit expansion and exports towards
internal sources of growth, especially as growth models that mainly rely on
exports are likely to be less effective than in the past.

Chapter IV: The limits of monetary policy

The major advanced economies are maintaining extraordinarily accommodative
monetary conditions, which are being transmitted to emerging market
economies (EMEs) in the form of undesirable exchange rate and capital flow
volatility. As a consequence of EME efforts to manage these spillovers, the
stance of monetary policy is highly accommodative globally. There is
widespread agreement that, during the crisis, decisive central bank action was
essential to prevent a financial meltdown and that in the aftermath it has been
supporting faltering economies. Central banks have had little choice but to
maintain monetary ease because governments have failed to quickly and
comprehensively address structural impediments to growth. But the need for
prolonged accommodation has to be carefully weighed against the risk of
generating distortions that will later produce financial and price instability.

Chapter V: Restoring fiscal sustainability

Sovereigns under fiscal pressure have been losing their risk-free status – and
the accompanying economic benefits – at an alarming rate. The broad
availability of safe assets aids the operation of financial markets and the
conduct of monetary policy. And a sovereign whose debt is essentially free of
credit risk has ample room to implement countercyclical policies to support
macroeconomic stability. Restoring the supply of risk-free assets requires that
governments convincingly address high deficits as well as projected increases
in their long-term liabilities. Some countries need to take immediate action to
significantly reform their public sectors and remove structural impediments to
growth. All countries need to prevent adverse feedback loops between the
financial sector and the sovereign and build up fiscal buffers in good times.

Chapter VI: Post-crisis evolution of the banking sector

Banks and prudential authorities still face tough challenges in securing financial
stability. Banks need to further strengthen capital and liquidity positions to
regain markets’ confidence. To expedite this process, authorities should ensure
that institutions recapitalise and recognise losses on problematic investments.
Authorities everywhere must complete their consistent and timely
implementation of the agreed Basel III standards and ensure that robust
regulation extends to currently unregulated intermediaries. Meanwhile,
regulators in rapidly growing economies should be aware of the potentially
destabilising risk-taking encouraged by buoyant local markets. The long-term
objective of policy must be to pave the way to a robust business model of
banking featuring strong and transparent balance sheets, self-sustaining
international operations, and stable profits that do not rely on official support.

http://www.bis.org/publ/arpdf/ar2012e.pdf

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