Aggregate Debt Levels Continue to Grow

Italian economist Claudio Borio is considered an authority in the areas of monetary policy, banking, finance and financial stability.

Borio heads the Monetary and Economic Department at the Bank for International Settlements. While at a seminar organized by the Latin American Reserve Fund last week, he gave an exclusive interview to Portafolio, BIS.org reported.

Q: What is your opinion on the performance of the global economy?

In the short term, over the next year or so, the outlook seems favorable in spite of the soft patch we saw at the beginning of 2018. Nevertheless, I would point out a number of specific features. The first is that it is highly unusual to see such strong momentum so late in the expansionary phase while at the same time inflation remains under control.

The second is that we are seeing rising protectionist pressures. The third is that financial markets appear overstretched. But perhaps the biggest concern is that aggregate debt levels in relation to global GDP have continued to grow.

Q:Why does that concern you?

Because that was the problem that ignited the 2008 financial crisis, and the scope to respond is much more limited now than it was then. From both the monetary policy and the fiscal perspective, the room for maneuver is much smaller.

Q: Are things different this time?

It depends on what is meant by "different". On the one hand, some tensions are very familiar and they are never going to change—that is, some mechanisms behind instability are always present. And of course, there will always be challenges and recessions.

On the other hand, many emerging market economies are better prepared now because they have a good international reserve position and they allow their exchange rates to float more freely. Another thing that has changed is that banks have retreated internationally, and now capital markets are the most exposed. Any problems will be seen more in the asset management sector.

Q: Against that backdrop, does it worry you that there is now less regulation, for example in the United States?

There are financial, economic and regulatory cycles, and I think that we are close to the peak of a regulatory one. The challenge is not to lose what we have accomplished so far, because the pressures to erode some of what has been done are clear. Having said that, in the specific case of the United States, the regulatory requirements were higher than those agreed at the international level.

Q: What do you think about emerging market economies?

I think the risks they face are not fundamentally different from those of some industrialized economies, because the tensions are similar. The difference is that they are more vulnerable, because they are more exposed to international capital flows, especially in dollars.

In the BIS Annual Economic Report, we discuss risks that deserve attention: the possibility of a sharp adjustment in sovereign bond yields (snapback) if inflation in advanced economies rises unexpectedly and its impact in EMEs, something which is not taking place right now; a reversal in risk appetite, with investors seeking more security due to untoward political or economic events and moving their money into German or US sovereign securities; and also the danger of protectionism if this trade war continues, which could turn into a currency war. A further appreciation of the dollar would exacerbate vulnerabilities in EMEs.

Q: What form might a currency war take?

If one country began to raise tariffs, the currency of the nation affected by those measures could depreciate due to market pressures. As this would make the trade barrier less effective, it could be misinterpreted as an attempt to manipulate exchange rates, which would give rise to further protectionist measures and a kind of vicious circle.

Q. Have we failed to learn a lesson from the previous financial crisis?

Some lessons were learned, especially in terms of financial regulation. But others were ignored, such as the importance of structural policies, which are the only way to achieve sustained growth.

One of the problems we are now facing results from the fact that the responses to the crisis were unbalanced: little was done on the fiscal and structural sides, and much was done on the side of monetary policy. Central banks took on too much of the burden. They laid the foundation for the recovery, but also created vulnerabilities because of the very low interest rates.

Compared with a year ago, the situation, looking ahead, is more worrisome.