People shop at Walmart Supercenter in Toronto on March 13, 2020. Carlos OSORIO/Reuters
The Bank for International Settlements warned in its annual report released on Sunday that many economies are approaching a critical point where high inflation will normalize while economic growth slows sharply.
The BIS, which acts as the bank for the world’s central banks, said countries around the world were facing a dangerous cocktail of high inflation, slow economic growth and financial vulnerabilities linked to high debt and rising interest rates.
The organization said this could quickly become a period of inflation similar to the high inflation and low growth periods of the 1970s and 1980s. It argued that economic policymakers around the world must act quickly to curb inflation, even if it means significant economic difficulties.
“We could reach a critical point beyond which an inflationary psychology expands and gets trapped. That would mean a big paradigm shift,” said Bis.
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Central banks around the world have accelerated rate hikes in recent months to tame inflation. Two weeks ago, the US Federal Reserve announced the largest rate hike since 1994. The Bank of Canada has raised interest rates on three consecutive interest rate decisions and has indicated it is considering a 0.75 percentage point hike in July. This would be three times the normal rate hike.
The interest rate creates less demand in the economy, which can help slow consumer price growth. But higher interest rates can push the economy into recession as higher borrowing reduces consumer spending and business investment and increases unemployment.
“The overriding challenge in the near term is to prevent the global economy from transitioning from a low to high inflation regime. In doing so, policymakers must limit the costs to the economy and protect financial stability as much as possible. However, some pain will be inevitable,” the BIS said.
Keeping inflation under control is not easy, the organization warned. The recent commodity price shock related to the Russian invasion of Ukraine has added to the much inflationary pressure that has built up over the past year. It is similar to the oil price shock in the 1970s that plunged the United States, Canada and other countries into a period of high inflation, high unemployment and low economic growth known as stagflation.
However, the BIS warned that the situation today could be more dangerous than in previous periods due to the high level of debt – particularly housing market lending – which has led to more than a decade of extremely low interest rates. was taken. She called the current combination of rising inflation and advanced financial vulnerabilities “historically unprecedented”.
“Unlike in the past, stagflation is now accompanied by heightened financial vulnerabilities, including rising asset prices and higher debt levels, which could exacerbate any growth slowdown,” it said.
Central banks are attempting a soft landing while raising interest rates – A situation in which inflation falls without a sharp slowdown in economic activity or a significant increase in unemployment. Top central bankers, including Fed Chair Jerome Powell and Bank of Canada Governor Tiff McCalem, have said in recent weeks that they believe a soft landing is possible, although acknowledging that it is becoming more difficult. .
In its report, the BIS threw cold water on the possibility of a soft landing. BIS economists examined tightening monetary policy cycles in 35 countries between 1985 and 2018 and concluded that almost half of them resulted in a soft landing – ie did not end in a recession.
However, further analysis showed that a recession was more likely when rate hikes were followed by a period of extremely low borrowing costs and the build-up of financial vulnerabilities. This is the situation in Canada and many other advanced economies today.
“A hard landing is unpredictable,” wrote Adam Tooze, a professor at Columbia University, in a newspaper commenting on the BIS report. “But what the BIS is telling us is that central bankers have never attempted to contain inflation as quickly as we have seen in the first half of 2022, which we have seen since the early 2000s. have seen. .”
The BIS is not alone in its gloomy prognosis. Earlier this month, the World Bank cut its global growth forecast for 2022 to 2.9 percent from its forecast of 4.1 percent in January, saying “the risk of inflation remains significant today.”
Much of the BIS review focuses on the changing dynamics of inflation, which is rising in much of the world for the first time in decades. Canada’s annual inflation rate rose to a 39-year high of 7.7 percent in May, the highest since 1983. It averaged 9.2 percent among Organization for Economic Co-operation and Development countries in April.
The BIS notes that consumer price growth tends to be self-reinforcing when economies enter periods of high inflation. Businesses and consumers are becoming increasingly aware of rising prices and are beginning to behave differently, setting higher prices and demanding higher wages to protect their margins or purchasing power.
“Whether or not inflation remains captive ultimately depends on whether a wage-price spiral develops. The risk should not be underestimated given the inherent dynamics of moving from low to high inflation regimes,” the BIS said.
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