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Global liquidity has become a key focus of the international policy debate and a buzz word in the financial press. Yet, it is a vexed issue, as there is no commonly agreed conceptual framework. In the first part of BIS general manager Jaime Caruana's talk, he steps back and reviews the definition of global liquidity that has been adopted by the Committee on the Global Financial System for its regular monitoring of financial vulnerabilities.
Based on this, he then briefly discusses current global liquidity conditions. Some elements of credit growth, particularly cross-border flows, remain muted in comparison to past liquidity surges. At the same time, the macro-economic environment in the major economies is still weak and uncertain. These trends would seem to allow a fairly benign interpretation of global liquidity conditions from the financial stability viewpoint. Yet monetary policy remains highly accommodative and investor risk appetite has picked up, albeit without much conviction – and these are two developments that, in the past, have accompanied build-ups of financial vulnerabilities.
Growth in international credit seems to indicate more benign global liquidity conditions in comparison to past liquidity surges. Even for emerging Asia and Latin America, cross-border bank credit has slackened, although the reasons are unclear.
Nevertheless, there are areas of concern. In the short term, global liquidity could suddenly evaporate if risk factors should materialise in the form of renewed euro area strains, US fiscal discontinuity or a sharp slowdown in emerging market growth. In the medium term, the risks arise from current levels of credit, private and public, in many economies. In advanced economies, debt needs to be reduced if the recovery is to be self-sustaining. However, the pace of private deleveraging in advanced economies has been slow, delaying the necessary balance sheet repairs. Unless fundamental measures are taken, reliance only on central bank actions raises the risk of overburdening monetary policy. Meanwhile the public sector has leveraged up. For several emerging market economies, by contrast, recent years have been characterised by prolonged credit and property price booms. The latest developments in these economies, not least in Asia, point to the risk that the credit cycle may be turning – a signal that policymakers should focus their attention on making their financial systems more resilient.
Clearly, history never repeats itself exactly. Yet, even though much has already been done on the macro-prudential policy front, we need to avoid complacency – more action is likely to be needed before the lights will flash green again. In this regard, today’s seemingly benign global liquidity conditions can be seen as a window of opportunity – in which we should seize the chance to do whatever is necessary to assure the financial stability of tomorrow.