After so much quantitative easing (QE), it will be very hard for central banks like the Bank of England and the Federal Reserve to even begin reversing the extraordinarily loose policies without causing panic on the markets, it said.
The warning comes after monetary policy committee (MPC) members this week called for more QE in a further effort to get the economy moving.
But the IMF believes monetary policy has been so loose for so long that this extra round would simply give a short-term sugar rush to markets.
“Despite their positive short-term effects for banks, these central bank policies are associated with financial risks that are likely to increase the longer the policies are maintained,” it said in a report.
“The current environment shows signs of delaying balance sheet repair in banks and could raise credit risk over the medium term,” it warned.
And while the policies have helped banks, the IMF said other sectors are suffering.
“Financial stability risks may be shifting to other parts of the financial system, such as shadow banks, pension funds, and insurance companies. The central bank policy actions also carry the risk that their effects will spill over to other economies.”
The Bank of England has noted concerns about the harm to groups like pensioners, but maintains the MPC must take policy decisions based on the inflation target and the economy as a whole, and hopes that improving overall economic conditions will aid pensioners in the end.
The IMF also fears it will be hard for the central banks to unwind QE when a tighter policy is needed, potentially provoking sharp market reactions.
“Policy missteps during an exit could affect participants’ expectations and market functioning, possibly leading to sharp price changes.”
The Bank of England has so far indicated it will first seek to raise rates, then sell off the bonds it has bought.
But former MPC member Andrew Sentance warns this will require exceptionally careful management of expectations as any rise right now would shock markets.
“There needs to be a period where the public and business community are advised this is something that the MPC is going to need to do, and set out on a medium term path which might gradually raise rates,” he told City A.M. “There is a risk that the time never appears to be right to raise interest rates and unwind the bond purchases made under QE.”
“The longer we persist in a world of very low interest rates, the greater will be the shock to the private sector when interest rates do start to rise.”