Institute of International Finance warns over too much liquidity

The Institute of International Finance (IIF), which groups 450 banks, said that if central banks continue to flood money into the global economy, then any future bid to get it under control could itself destabilize the financial system.

“Much of the recovery so far has ... been heavily reliant on 'easy money' conditions fostered by central banks,” the IIF said in a statement,

“These conditions — quantitative easing, very low interest rates — cannot last forever, but the risk is that financial markets have become addicted to them,” it warned.

“The longer central bank liquidity is relied on to hold things together, the more excesses and distortions are being accumulated in the financial system. An eventual unwinding of these excesses will become a destabilizing risk event.”

The IIF said the U.S. Dow Jones Industrial Average's had hit an all-time high this week more because of relaxed international monetary conditions than thanks to any recovery in the real economy.

The group also said that major central banks are doing “whatever it takes” to stabilize markets and boost growth because necessary reforms are being stalled by political deadlock in manycountries.

“The critical problem resulting from prolonged political stalemate is that essential policy reforms could be delayed — with the consequence that wider investor confidence may be undermined,” the banks said.

IIF deputy managing director Hung Tran said that central bankers should be aware of “the unintended consequences of their actions” and make clear how they expect to adjust monetary policy over the long term.

The warning came hours after European Central Bank policy makers discussed a cut in its benchmark interest rate to address the weak eurozone economy. They ultimately decided to keep the rate on hold, as did the Bank of Japan and the Bank of England at their policy meetings Thursday.

All three continued to pursue strongly expansionary monetary policies.

U.S. Federal Reserve chief Ben Bernanke last week downplayed worries that liquidity was fueling fresh bubbles in financial markets. But he added that the Fed — which has held its key rate near zero since the end of 2008 — was monitoring the situation.

The IIF pointed to political divides hurting economic policy reforms in Italy, the United States and elsewhere.

It applauded Japan's efforts to boost its economy with increased easing, but added a warning.

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