G7 central banks shown yellow card

Prolonged monetary easing after Lehman crisis risky and difficult to disengage from, says IMF

The International Monetary Fund (IMF) has cautioned that the measures by central banks of the advanced nations to push their economies up the recovery path might have spilt risks to other economies.

It also cautioned that the measures might have shifted risk to other parts of the financial system. What was more, disengaging from such policies without further complications was also a sticky job.

In its global financial stability report, it said after the financial crisis had struck, the central banks in America, Britain, Japan and the euro area had taken many unconventional measures to address system vulnerabilities. These unconventional monetary policies include prolonged periods of very low interest rates, quantitative easing, and indirect and direct credit easing.

"Though this has improved some bank soundness indicators and has not harmed market liquidity, it is possible the financial stability risks are shifting to other parts of the financial system, and to other economies," the IMF said.

Many quarters have expressed concern that increase in money supply in the advanced world would jack up commodity prices worldwide and have repercussions for emerging market economies like India, struggling to contain inflation.

After standard tools turned ineffective in the wake of collapse of Lehman Brothers in late 2008, the US Federal Reserve resorted to quantitative easing for increasing money supply. In September 2012, it had announced a new $40-billion a month, open-ended, bond purchasing programme of agency mortgage-backed securities; also, to continue a policy of extremely low rates until at least mid-2015, called QE3.

This stimulus programme allows the Fed to relieve $40 billion a month of commercial housing market debt risk. also, in December 2012, its Open Market Committee had said it would raise the amount of open-ended purchases from $40 billion to $85 billion a month. This is sometimes referred to as 'QE4'. Similarly, the Bank of Japan had announced it would inject $1.4 trillion into the Japanese economy to end deflation and push up economic growth. The Japanese economy is in recession and the country's exports are in a slump. The IMF report cautioned that these steps cannot be sustained for the long term.

"Central bank liquidity no longer appears to significantly affect interbank market spreads in the US and the UK. This could indicate that future central bank exit from these markets would not affect interbank spreads there. In the euro area and Japan, however, the central bank appears to continue to mask more elevated interbank market spreads, due to increased sensitivity to counterparty risk," the report said.

The report said although these policies have short-term positive effects, the longer these are maintained, the greater the long-term risks involved.

The report said central banks face challenges in leaving markets after intervening heavily. And, that any policy mistakes made during such an exit would affect the market's functioning.