The Bank for International Settlements (BIS), the organization that unites all of the world’s central banks, called for additional interest rate increases on Sunday, warning that the global economy had reached a critical juncture as nations struggled to control inflation.
While borrowing costs increased sharply over the past 18 months, inflation in many top economies has remained stubbornly high, leading to the most serious bank failures since the financial crisis of 15 years ago.
“The state of the world economy is critical. Stern problems must be tackled,” BIS general manager Agustin Carstens wrote in the organization’s annual report, which was released on Sunday.
“The time is passed for relentlessly pursuing short-term growth. Price stability must now be restored through monetary policy. Consolidate fiscal policies is necessary.
Although the larger-than-expected rate increases in Britain and Norway last week indicated central banks were striving “to get the job done” in terms of addressing the issue, Claudio Borio, the head of BIS’s monetary and economics unit, added there was a risk an “inflationary psychology” was now setting in.
However, compared to post-World War Two norms, their difficulties are exceptional. It is the first time in a significant portion of the world that spikes in inflation and pervasive financial vulnerabilities have coexisted.
The BIS research warned that the likelihood of more issues in the banking system was now “material” and that the longer inflation continues high, the stronger and longer the required policy tightening.
According to Borio, the aggregate debt payment burden for the world’s top economies would be the largest ever if interest rates reach levels seen in the mid-1990s.
“I believe central banks will control inflation. Restoring price stability is their responsibility, he told reporters. “What will it cost?” is the query.
Bank Failures
Top central bankers recently gathered for the BIS’s annual meeting in Switzerland to review the stormy recent months.
The demise of several regional American banks in March and April, including Silicon Valley Bank, was followed by the last-minute rescue of Credit Suisse in the BIS’s neighborhood.
According to the BIS analysis, historically, 15% of rate hike cycles result in significant stress on the banking system; however, the frequency increases significantly in situations where interest rates are rising, inflation is skyrocketing, or home prices have been growing quickly.
If the private debt-to-GDP ratio is in the highest quartile of the historical distribution at the time of the first rate hike, it may even reach 40%.
The BIS stated that “very high debt levels, a remarkable global inflation surge, and the strong increase in house prices during the pandemic era check all these boxes.”
The expense of caring for aging populations is predicted to increase by roughly 4% and 5% of GDP in advanced (AEs) and emerging market economies (EMEs), respectively, over the next 20 years.
Governments would need to tighten their belts in order to prevent debt from rising above 200% and 150% of GDP in AEs and EMEs by the year 2050. If economic growth rates slowed, the debt level may potentially rise higher.
A “game-changing” vision for an advanced financial system, where central bank digital currencies and tokenized banking assets speed up and smarten up transactions and international trade, was also included in the research that was already published last week.
Former Mexican central banker Carstens provided additional insight into the economic situation, stating that it was now crucial for policymakers to take action.
“Unrealistic expectations that have emerged since the Great Financial Crisis and COVID-19 pandemic about the degree and persistence of monetary and fiscal support need to be corrected,” the official said.
Although it acknowledges that it is a challenging scenario, the BIS believes that an economic “soft, or soft-ish” landing, when rates rise without sparking recessions or significant financial crises, is still conceivable.
A staggering 470 interest rate increases have been recorded worldwide during the last two years, as compared to 1,202 decreases since the financial crisis, according to analysts at Bank of America.
The European Central Bank increased rates in the eurozone by 400 basis points, and many developing world economies have done far more. The U.S. Federal Reserve increased its rates by 500 basis points from close to zero.
The question of what more will be required still lingers, especially in light of indications that businesses are maximizing profits and that people are now seeking greater pay to stop a further decline in their standard of living.
“The easy gains have now been reaped and the last mile is going to be more difficult,” said Borio in reference to the difficulties central bankers now face in bringing inflation back to reasonable levels. “If there were more surprises, I wouldn’t be surprised,”
