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Central bank group backs unconventional tools' role in fighting financial crisis

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Central bank group backs unconventional tools' role in fighting financial crisis

A group of global central bank officials said the advantages of using unconventional monetary policy tools, adopted after the 2008 financial crisis, outweighed their negative effects.

Central banks effectively tackled the challenges presented by the crisis with negative interest rates, lending operations, asset purchase programs and forward guidance, the Global Financial System Committee said in a report prepared by a working group co-chaired by Frank Smets from the European Central Bank and Simon Potter, formerly of the Federal Reserve Bank of New York.

The committee described asset purchase programs as "very effective," which, together with lending operations, aimed to lower long-term yields and ease financial conditions.

Concerns regarding bond-buying programs, like the risk of weakening central bank balance sheets' quality and spillovers in the form of pushing commodity prices higher and boosting private sector leverage in emerging market economies, were not considered strong enough to negate asset purchase programs' benefits.

Lending operations supported credit flows to the private sector and helped stabilize market expectations of interest rates, though concerns about an inefficient allocation of credit and an expected rise in leverage accompanied the tool.

With respect to negative rates, the report concluded that the policy offered the desired expansionary stimulus, and while compressed bank interest margins were among its side effects, they did not threaten banking stability.

Regarding the use of forward guidance, the surveyed central banks said the tool worked "reasonably well," though balancing trade-offs between clarity of message, credibility of follow-up action and flexibility of future policy response was a key challenge.

"Most of the central banks that implemented [these tools] have yet to unwind them, given the need for continued stimulus," according to the report, which was published under the Bank for International Settlements umbrella. "This means that a complete assessment of their effects can only be made at a later stage."

Policymakers should be mindful of potential risks of prolonged use of these tools, the Global Financial System Committee said, adding that they are more effective when accompanied by fiscal policies.

This comes days after declining interest rates in developed markets were cited as one of the top risks to global credit conditions by an S&P Global Ratings report, which also flagged concerns surrounding negative interest rates in Europe and Japan.

More dovish monetary policy measures than expected have been subject to criticism by some European Central Bank policymakers.