Dhe Bank for International Settlements (BIS) is concerned about high inflation rates around the world. In its annual report published on Sunday, the institution, which is considered the bank of central banks, warned of an era of high inflation. BIS Director General Agustín Carstens called on the central banks to act quickly and decisively. While the American Federal Reserve and the Bank of England have raised interest rates several times and significantly, the European Central Bank (ECB) does not intend to tighten until July.
Carstens currently does not see the risk of exaggerated rate hikes. At this point, swift and decisive action is better, he said. Many economists have accused the ECB of hesitant behavior and a belated reaction. Carstens did not agree with this criticism in the conference call to present the annual report. He named the Bank of Japan, which continues to be expansionary, and the central bank of China, which has even eased its monetary policy to support growth, as exceptions to the monetary tightening course.
Carstens pointed out that the ECB must also take into account the high national debt in some euro countries in its monetary policy. After an increase in the risk premium on Italian government bonds, the ECB convened a special meeting of the Monetary Policy Council on June 15 and then declared that it wanted to take action against a fragmentation of the financing conditions. According to Carstens, the high level of national debt can lead to tensions with what is required by monetary policy.
High debts make you vulnerable
The BIS, which is based in Basel, manages the central banks’ foreign exchange reserves and serves as their monetary policy think tank, considers the dangers of stagflation to be high. The BIS economists cite a combination of the aftermath of the corona pandemic as the causes, such as the supply chain disruptions, the Ukraine war and the existing financial vulnerabilities. These include persistently high levels of debt and overvaluations, particularly of residential real estate. The BIS warns in its current annual report, which is considered an important stocktaking for the developments on the financial markets and in monetary policy.
A soft landing, i.e. successfully combating inflation by raising interest rates without a recession, is still possible, but very challenging under the current conditions. For this, the BIS assumes that inflation rates will fall due to functioning supply chains and that commodity prices, which have “exploded” as a result of the Ukraine war, will fall at the same time. Then the central banks would not have to raise interest rates so sharply, which would slow down the economy less. But the BIS economists are not ruling out the worst-case scenario either: persistent inflation that would require very aggressive rate hikes by the central banks. That could trigger a recession combined with stress on the financial markets.
Shadow banking risks
The banking sector is currently in a better position due to the far-reaching reforms after the 2008 financial crisis due to the higher equity buffer. However, an economic downturn could trigger high loan defaults. These could be even larger if interest rates were to rise very sharply. The BIS is even more concerned about the risks in the unregulated non-bank financial sector. The so-called shadow banks, to which the BIS counts not only hedge funds but also asset managers, are vulnerable due to their hidden debts and possible liquidity bottlenecks. Once again, the BIS economists call for more regulatory efforts in the unregulated areas of the financial market.
The BIS currently sees the development of wage-price spirals as a risk. Although these cannot yet be observed across the board, wage negotiations are still to come in most countries. Carstens referred to Europe here. High wage demands and an adjustment to inflation can already be heard. “As the cake gets smaller, the fight for it gets bigger,” says the BIS, describing the initial situation. Carstens warned central banks against hesitation: “Once inflation is established, the cost of bringing it back under control will be higher. The longer-term benefits of maintaining stability for households and businesses outweigh the short-term costs.”
Inflation puts states under pressure
The BIS sees the still historically high government debt as a major problem. These would rise again as a result of an economic downturn, even if government spending could weaken the economic headwind somewhat. Demands for state aid are likely to become all the louder if the cost of living rises significantly with energy and food prices. This is all the more worrying for the BIS, because the tightening of monetary policy to combat inflation will make government financing costs more expensive.
Fiscal and monetary policy have tried to stimulate growth for too long without considering the underlying causes of the weaknesses. Fiscal policy was expansive during downturns, but neglected consolidation during upswings.
“The short-term challenge of maintaining low inflation coexists with the longer-term challenge of rebuilding buffers in macroeconomic policies,” said Claudio Borio, head of the BIS Monetary and Economic Department. The pressure on fiscal policy is increasing. This complicates the task of monetary policy and highlights the importance of reform to ensure long-term growth.
