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Central banks have almost run out of options on how to help stave off the latest volatility in world economies, BNZ senior economist Craig Ebert says.
The United States Federal Reserve yesterday pledged to keep its key interest rate at its record low of nearly zero through to the middle of 2013.
The central bank also said it had discussed "the range of policy tools" it could use to spur the economy.
The Fed's statement was interpreted to mean that another round of fiscal stimulus could be on the way as the central bank worked to keep rates low.
However, Mr Ebert believed that while it was seen as "good" the Fed had held its rates to close to zero, that was what got the United States, and the global economy, to the state it was now in.
The Fed held its rates low when the Nasdaq sharemarket crashed and after the terrorism attacks.
"In the end, cheap money has proved to be dangerous. Funding costs out of America is next to zero. That is dangerous for parts of the world. The problem with free money is creating massive Keynesian deficits."
The orthodox methods of fixing financial crises were not working well, Mr Ebert said. There was only so much policymakers could do.
One of the problems had been people relying on policymakers to "save their bacon".
There was an underlying feeling that there was only so much policymakers could do to stem the rise of debt.
The latest problems were different from those in 2008, he said. Then there was no shortage of cash liquidity around the world but people did not trust policymakers to use it wisely so they were keeping it close instead of investing.
This time, the world debt had built up to massive proportions based on policymakers pandering to people who wanted to build up debt.
"It looked good at the time, but it was all based on a house of cards and those cards have now fallen. Debt is out of all proportion to economic reality."
It was time for policymakers to knuckle down and start dealing with the debt loads, Mr Ebert said.
In the private sector, households and businesses had started paying down debt.
It had hurt and hard decisions had to be made on spending. But it was all about choices and deleveraging was well under way in the private sector.
The offshoot was huge public-sector debt, the Keynesian idea of racking up public debt which became a liability for future generations.
"It's never easy to solve. But if you have a massive free party then you are going to wake up to a long and painful hangover."
In the US, politicians were starting to talk about tax reform and trimming the out-of-control public sector. More needed to be done.
One of the major problems was the ability to write off mortgage payments against income and the ability to walk away from a mortgage - posting in your house keys - if things turned bad.
The two Government-owned mortgage companies Fannie Mae and Freddie Mac were underwriting mortgages, meaning taxpayers were responsible for mortgages of sometimes dubious quality, Mr Ebert said.
Greece was technically in default of its government debt and people were starting to talk about Argentina, which in 2003 defaulted on its debt. While that was good for Argentina, it was a problem for people who had lent money to that country.
If Greece defaulted, it could bankrupt large tracts of the European banking system.
"The debate now is who is going to take the pain and over what period," he said.
Craigs Investment Partners broker Chris Timms took a different stance, believing that low interest rates in the US would encourage businesses needing cash flow to save their operations to borrow and bridge the immediate problem.
The Fed only provided a platform of low interest rates; it was up to the corporates to decide if they needed to borrow and the banks to decide if the companies were in good enough shape to pay back the money.
The rules had changed substantially in the past two to three years, he said.
"Lower borrowing costs means people can raise capital as required, encouraging them to get productivity under way."
Keynesian economics: A supporter of Keynesian economics believes it is the government's job to smooth out the bumps in business cycles. Intervention would come in the form of government spending and tax breaks in order to stimulate the economy, and government spending cuts and tax hikes in good times, in order to curb inflation. - Investopedia