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Leading economies at risk of falling into high-inflation trap, BIS says

Leading economies are about to “tip” in a high inflation world where rapid price increases are common, dominate everyday life and are hard to suppress, the Bank for International Settlements warned Sunday.

In its annual report, the BIS, the influential body that operates banking services for the world’s central banks, said these transitions to high inflation environments were rare, but very difficult to reverse.

The BIS noted that many economies had already started the process and advised central banks not to hesitate to inflict short-term pain and even recessions to avoid a transition to a world of persistently high inflation.

Agustín Carstens, managing director of BIS, said: “The key for central banks is to act quickly and decisively before inflation becomes entrenched.”

Central banks around the world have begun raising interest rates rapidly in response to rising inflation, with the US Federal Reserve leading the way, but the measures taken so far are not satisfying the BIS.

Line chart of the proportion of countries with inflation above 5 percent showing The proportion of countries with high inflation has exploded

In its report, the bank said there was a deep, “inherently stagflationary” shock hitting the world as a result of higher commodity prices, supply chain bottlenecks and shortages caused by the Russian invasion of Ukraine.

As a result, prices of the goods and services most noticed by households had risen, reinforcing the conspicuousness of price increases.

“Perhaps we will reach a tipping point, after which an inflationary psychology will spread and become entrenched. This would represent a major paradigm shift,” the report said.

Such a shift would mean leaving behind a world where prices have generally been stable, with some things getting cheaper and others more expensive. In this benign world, central banks have managed to ignore temporary increases in oil or natural gas prices because “economy-wide inflation [is] less noticeable [and] also less relevant”.

After a transition to a period of high inflation, “price changes are much more synchronized and inflation is much more of a focal point for the behavior of economic agents, exerting a major influence on them”.

In several economies, including the US, the Eurozone and the UK, inflation is at its highest point in decades. The BIS was concerned that the leading economies of North America, Europe and many emerging markets were close to tipping. Consumers had noticed price increases, large increases had widened for most commodities, and falling real wages would attempt to make up for the losses.

Ignoring price increases was no longer rational for consumers, the BIS said, adding to the danger of a shift to a high inflation world.

Line chart of consumer inflation basket share with price increases above 5 percent, showing high inflation has broadened

“As inflation mounts and becomes a focal point for agent behavior, behavior patterns tend to amplify the transition,” it added, predicting companies would fight to avoid straining profit margins. and that workers would defend their wages. The length of most contracts would tend to shrink, it added, as parties on both sides could not guarantee price levels going forward.

To curb inflation, the BIS said, “some pain will be inevitable”, but ultimately said the difficulties of entrenched inflation “far outweigh the short-term difficulties of controlling it”.

“This puts a premium on a timely and decisive response,” it told its member central banks, even if no one could be sure they had entered a high-inflation environment.

The BIS added: “The top priority is to avoid falling behind, which would eventually lead to a more abrupt and forceful adjustment. This would increase the economic and social costs of controlling inflation.”

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