Australia’s Stevens Says World Mustn’t Retreat From Risk Taking

By Jacob Greber

Feb. 10 (Bloomberg) -- A worldwide retreat from the cycle of risk-taking could be even more damaging to future economic growth than the global financial crisis, according to Australia’s central bank Governor Glenn Stevens.

“The problem in the next couple of years will not be too many cross-border capital flows, but too few; not too much risk- taking, but too little,” Stevens said in the text of a speech to be given in Kuala Lumpur today. “A retreat into financial autarky and wholesale shunning of risk would be even more damaging than what we have seen to date.”

Stevens is among central bankers around the world that have cut interest rates as economies including the U.S., Europe and Japan sink into recessions because of fallout from the global credit freeze. Financial institutions worldwide have amassed $1.09 trillion of losses and shed almost 270,000 jobs since the U.S. subprime mortgage market collapsed, according to data compiled by Bloomberg.

A major complication for some countries is that “some of the transmission channels of monetary policy are not working normally,” Stevens said.

“The most damaging instances have been in the U.S. and U.K. where, despite quite aggressive reductions in the interest rates set by the central banks, rates paid by many borrowers have not fallen very much until quite recently,” he said.

Even where interest rates have declined, many commercial banks “display an individually understandable, but systemically damaging, reluctance to lend,” Stevens said.

Lending Concern

Australian Prime Minister Kevin Rudd said last month his government will take “whatever action is necessary” to aid the financial system should foreign banks fail to roll over up to A$75 billion ($50 billion) in loans to local businesses.

A shortfall in credit could push Australia into its first recession since 1991. The economy grew 0.1 percent in the third quarter, the weakest pace in eight years.

Global credit markets seized up following the bankruptcy of Lehman Brothers Holdings Inc. in September 2008, prompting governments around the world to bail out financial institutions and boost spending to revive growth.

“In the short term, the situation requires flexibility and a degree of innovation on the part of central banks, and on occasion not a little boldness,” Stevens said.

The U.S. Federal Reserve and Japan’s central bank have pared their key rates close to zero, the European Central Bank to 2 percent, matching a record low, and the Bank of England to 1 percent, the lowest since the institution was founded in 1694.

Stevens cut his benchmark rate by 4 percentage points since early September to a 45-year low of 3.25 percent. Australia’s lenders have passed on most of those reductions to mortgage borrowers, around 90 percent of whom have variable-rate loans.

Australian Economy

The drop in borrowing costs is among reasons the Reserve Bank of Australia expects the nation’s economy will expand 0.5 percent this year. By contrast, the International Monetary Fund forecasts contractions in the U.S, Europe and U.K. of 1.6 percent, 2 percent and 2.8 percent respectively.

The U.S., Switzerland and “one or two other countries” are facing the prospect of dealing with the limits of monetary policy as benchmark lending rates approach zero, “a theoretical curiosum until Japan’s experiences over the past decade,” Stevens said.

“For this reason, so-called ‘unconventional’ policy instruments are starting to come into view in some countries,” he said. These include the purchase of assets by central banks.

In future, Stevens said central bankers and regulators will need to devise new ways of operating “effectively on the assumption that we will never have the full picture of the workings of the financial system and the real economy.”

Be Skeptical

Authorities need to be more skeptical about the latest financial innovations, and maintain a “much greater degree of distrust of leverage, in all its forms,” he said.

“Many investors, if they were honest, would have to admit that they knew that they did not fully understand the instruments, yet they were not deterred from investing,” Stevens said.

“The simple point, surely, was that there was too much optimism combined with too much leverage. That is neither new, nor particularly complicated,” he said, adding that it will probably “periodically recur.”

Central bankers can’t avoid revisiting the question of whether monetary policy should be used to control asset-price bubbles, the governor said.

Following the collapse of the dot-com bubble in 2001, those who supported the use of interest rates to temper rising asset prices, such as stocks and property, failed to get enough traction, “I suspect mainly because growth in the U.S. was fairly easily restarted after the shallow recession of 2001.”

Stevens’ speech didn’t address monetary policy in Australia or the nation’s economy.

To contact the reporter for this story: Jacob Greber in Sydney at jgreber@bloomberg.net