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The end is nigh, says world's central bank -

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The end is nigh, says world's central bank

The World Today - Tuesday, 1 July , 2008 12:18:00

Reporter: Stephen Long

ELEANOR HALL: The Board of the Reserve Bank will almost certainly have decided to leave interest
rates on hold this morning at a 12-year high.

But there would have been no shortage of issues to discuss at the meeting.

In particular the release of a disturbing assessment of the state of the world economy by the
central bank for central banks.

The economic forecast by the Swiss-based Bank for International Settlements is at odds with the
RBA's more rosy outlook.

With more we are joined now by economics correspondent Stephen Long.

Stephen, most economists have been predicting that the Reserve Bank Board will leave interest rates
on hold this morning but is there anything in this international report to change that?

STEPHEN LONG: No Eleanor. I think in many ways this report is actually implicit endorsement for the
stance that has been taken by Glenn Stevens as the head of the Reserve Bank of Australia of keeping
rates relatively high - at 12 year highs and really pushing against inflation in the face of some
pretty strong criticism.

Now it doesn't go to whether rates should move today obviously a global report like this but it is
highly critical of the stance that central banks took around the world in recent years of having
rates quite low when inflation seemed to be benign and what they are arguing, what the Bank for
International Settlements, the central bank for central banks is arguing is that that fuelled the
credit binge and the inflation pressures that we have in the world today and that central banks
should really have been leaning against the credit excesses to stop them happening and that indeed
is what they should do now.

ELEANOR HALL: But inflation was low during much of this decade around the world, so is this central
bank for central banks suggesting that they should have been lifting rates or doing something
different?

STEPHEN LONG: It is very much a suggestion that central banks and policy makers got it wrong. What
it argues is that there a number of cascading and overlapping forces that gave rise to this crisis
but at the heart of it was loose credit and credit binge.

I will quote one section where it says "a powerful interaction between financial market innovation,
lacks internal and external governance banks and easy global monetary conditions over many years
has led us to today's predicament".

So what they're saying is that we should have been having rates much higher when things looked fine
because they weren't. In fact we actually had an economic shock ironically coming from the cheap
imports coming from China because that was unsustainable.

China and the developing world were keeping their currencies artificially low fuelling cheap
imports which led to supposedly low inflation in the West which made everyone think things were
hunky-dory when they weren't.

ELEANOR HALL: So what does the Bank for International Settlements see as the biggest threat the
world economy; the global credit crisis or rising inflation?

STEPHEN LONG: The key insight from this report is that the two forces are actually linked so you
can't look at them in isolation. In a binary opposition, we are either going to see the economy
tank or inflation, we've got to deal with one or the other - the financial crisis or the inflation
crisis.

ELEANOR HALL: And yet that is the way that central banks have been looking at it.

STEPHEN LONG: Very much so and there is an attack on some of the policies that have been pursued
lately. I think there is a implicit criticism of the Federal Reserve in the US with its bailing out
of private sector banks and its rate cuts.

But what they argue is that the excessive and impudent credit growth that has happened over a long
period was always going to unleash inflation as well as an unsustainable accumulation of debt.

The two go hand in hand. Now the difficult thing then coming out of that Eleanor, is that it says
there is no easy and simple policy solutions but very much they argue that really, we can't be
looking now as they are say in the US or have been until recently, to run negative real interest
rates to bail out the economy and keep on cutting them because it will lead to inflation.

Horns of a dilemma though, no easy answers. Pretty tough times.

ELEANOR HALL: Stephen Long, our economics correspondent, thank you.