Central Banks’ Ongoing Struggle to Tame Inflation: Insights from BIS
Introduction: Inflation, which soared to multi-decade highs, has begun to recede in many economies. However, according to the Bank for International Settlements (BIS), central banks still face significant challenges on the path to restoring price stability. Despite their extensive efforts in tightening monetary policies, the final phase of this journey proves to be the most demanding.
Factors Behind Inflation Moderation: The progress achieved thus far in the battle against inflation can be attributed to the alleviation of supply chain disruptions and the decline in commodity prices. Yet, labor markets remain tight, and controlling price growth in the services sector has proven to be more challenging. There exists a tangible risk of an inflationary psychology taking hold, where wage and price increases mutually reinforce each other. Consequently, the BIS’s Annual Economic Report 2023 suggests that interest rates may need to remain higher for longer than anticipated by the public and investors.
Inflation Risks and Financial Stability: The report assesses the risks arising from the combination of elevated inflation and financial stability concerns. Central banks find themselves tightening policies against a backdrop of high debt levels and inflated asset prices, a consequence of increased risk-taking during the prolonged period of low interest rates. While the closure of banks in early 2023 serves as a prominent example of these risks materializing, it is not the sole concern. The non-bank financial sector harbors hidden leverage and liquidity mismatches, posing another vulnerability. Should central banks be required to prolong or intensify their tightening measures to achieve price stability, the risk of financial stress will escalate, warns the report.
Addressing the Challenges: To stabilize the economy and financial system, fiscal and prudential policies must play their part. Governments should adopt measures to tighten their budgets, with a focus on providing support to the most vulnerable segments while undertaking long-term spending consolidation. This approach would aid in curbing inflation and mitigating financial stability risks by reducing the necessity for prolonged higher interest rates. Regulatory and supervisory authorities should employ the full range of tools at their disposal to strengthen the financial system, thereby granting central banks greater maneuverability.
Safeguarding Stability for the Future: Looking ahead, both policy adjustments and institutional safeguards are crucial to ensuring that monetary and fiscal policies remain firmly within the realm of stability. By establishing robust frameworks, authorities can navigate economic challenges more effectively and maintain equilibrium in the face of evolving circumstances.
Conclusion: Despite the easing of inflation from its record highs, central banks continue to grapple with the task of restoring price stability. The interplay between various factors, such as supply chains, labor markets, and inflation psychology, adds complexity to this endeavor. Moreover, central banks must navigate the risks to financial stability arising from elevated debt levels and asset prices. A coordinated effort involving fiscal policies, regulatory measures, and institutional safeguards is vital to alleviate these challenges and maintain stability in the long run.
