The level of global debt concerns me

Translation of an interview with Mr Claudio Borio, Head of the Monetary and Economic Department of the BIS, with Portafolio, conducted by Mr Ricardo Ávila on 9 July 2018.

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 organised by the Latin American Reserve Fund (FLAR) last week, he gave an exclusive interview to Portafolio.

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

In the short term, over the next year or so, the outlook is favourable 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.

Why does that concern you?

Because that was the problem that ignited the 2008 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 manoeuvre is much smaller.

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 (EMEs) 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.

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 to not 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 (gold plating).

What do you think about emerging market economies?

I think the risks they face are not fundamentally different from those of some industrialised 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.

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.

Economists talk about the need to have in place macroprudential measures. Whose job is that?

First, those measures are needed when a rise in vulnerabilities is detected in a given economy. That said, experience shows that they are more effective at strengthening financial systems than at preventing things like credit expansion or increases in the prices of certain assets - housing, for example. In short, they need to be used together with other tools and policies. In terms of governance, there is no "one size fits all" solution. The most common one is a committee in which different government agencies take part. Clearly central banks have a role to play, since they have a lot of specific know-how.

How should the fiscal situation be addressed in a world that is moving towards lower tax rates, as in the United States?

Improving fiscal accounts is a challenge for all economies, developed or not.

Here it's important to keep in mind that financial imbalances such as significant increases in credit or asset prices hide fiscal problems. This occurred, for instance, in Ireland and Spain in the years leading up to the crisis. That said, the example being set by some developed economies with respect to taxes is not the appropriate one. 

Do developed or emerging market economies worry you more?

I think EMEs will be at the forefront of what occurs. If you take a step back and look at the 2008 crisis, you will see that some countries were directly affected and others were not. In the affected countries, the private sector has deleveraged, reducing debt in relation to income. 

In the unaffected ones, pressures have continued to build, among other reasons because of strong capital inflows. Post-crisis, the level of dollar-denominated debt in non-banking sectors in EMEs has doubled. Some economies have strengthened their defences, but the risk is clear.

Does that mean that we failed to learn the lesson of the 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, are you more or less worried?

Looking ahead, more worried.