Restoring price stability as inflation subsides will pose a significant challenge for central banks, the Bank for International Settlements (BIS) says in its 2023 Annual Economic Report.
BIS suggests that improvements in inflation levels have been due to supply chains easing and commodity prices falling, but highlights the fact that labour markets remain tight and price growth in services has continued.
As a result, it warns, an “inflation psychology may take hold”. This would mean that wage and price increases reinforce each other, and would prompt interest rates to remain at a higher point for longer than expected.
In its report, BIS identifies the risks associated with the current environment of both high inflation and financial stability risks. These include bank closures, hidden leverage and liquidity mismatches in the non-bank financial sector and increases in financial stress as central banks increase or extend their tightening measures.
This tightening is due to high debt and asset prices resulting from long-term risk-taking behaviour in a long-term low interest rate climate, BIS states.
To stabilise the financial system and the economy, governments must tighten their budgets, support the most vulnerable and consolidate their spending on a long-term scale, BIS advises. In addition, it says, regulatory and supervisory bodies must work to strengthen the financial system around central banks and allow them more flexibility.
Agustín Carstens, general manager of BIS, comments: “The key policy challenge today remains fully taming inflation, and the last mile is typically the hardest. The burden is falling on many shoulders, but the risks from not acting promptly will be greater in the long term. Central banks are committed to staying the course to restore price stability and protect people's purchasing power.”
Claudioi Borio, head of the BIS monetary and economic department, says: “The current tensions are the culmination of decades of reliance on monetary and fiscal policy as de facto engines of growth. Overcoming this 'growth illusion' fallacy and finding a coherent policy mix requires a change in mindsets, recognising the limitations of stabilisation policies.”
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