Writing in its latest Annual Economic Report, the Bank for International Settlements (BIS) has warned that the global economy risks entering a new era of high inflation. Stagflation dangers loom large, as a combination of lingering disruptions from the coronavirus pandemic, the war in Ukraine, soaring commodity prices and financial vulnerabilities cloud the economic outlook. “The key for central banks is to act quickly and decisively before inflation becomes entrenched,” says Agustín Carstens, General Manager of the BIS. “If it does, the costs of bringing it back under control will be higher. The longer-term benefits of preserving stability for households and businesses outweigh any short-term costs.”

Priority to restore low and stable inflation

The BIS’s Annual Economic Report says that central banks should give priority to restoring low and stable inflation. In doing so, they should seek to minimise the hit to economic activity, thereby safeguarding financial stability. Engineering such a “soft landing” has historically been difficult, and the starting conditions today make this challenging, the BIS says. 

Nevertheless, the BIS is upbeat overall that a repeat of the 1970s stagflation is unlikely because, amongst other things, monetary policy is now better at responding to such situations and economies are less reliant on fossil fuels than they were back then. At the same time, the BIS warns of the dangers that could arise from a combination of high private and public debt levels and a possible correction of overvalued asset prices, such as those of equities and real estate.

Borio highlights importance of reforms

“The near-term challenge of ensuring low inflation co-exists with the long-standing one of regaining future safety margins in macroeconomic policies,” added Claudio Borio, Head of the BIS Monetary and Economic Department. “Pressures on fiscal policy are mounting. This complicates the task for monetary policy and highlights the importance of reforms to support long-term growth.”

Digital money of the future grounded in trust in central banks

The report also analyses the demands that the digital era places on the financial system and advocates the introduction of central bank digital currencies (CBDCs). Such a system “could combine innovation with essential attributes such as safety, stability, accountability, openness and efficiency,” the BIS writes, which is why it has to be built on the foundation of trust in central banks, with a digital version of sovereign currencies at its core. According to the BIS, building up the digital financial system is a joint task. Its experts see the private sector taking on the role of developing efficient payment capabilities and customer-facing activities such as the tokenisation of financial instruments.