Biggest economies risk falling into high inflation trap, says BIS

The world’s major economies are close to “leaning” towards a world of high inflation, where rapid price increases are normal, dominate everyday life and are difficult to contain, the Bank for International Settlements warned on 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 happened rarely but were very difficult to reverse.

Diagnosing that many economies had already embarked on the process, the BIS recommended that central banks not be afraid to inflict short-term hardship, and even recessions, to avoid shifting to a world of persistent high inflation.

Agustín Carstens, general manager of the BIS, said: “The key for central banks is to act quickly and decisively before inflation sets in.”

Central banks around the world have started raising rates rapidly in response to rising inflation, with the US Federal Reserve leading the pack, but the measures taken so far have not satisfied the BIS.

In its report, the bank said there had been a deep “intrinsically stagflationary” shock that hit the world due to higher commodity prices, supply chain bottlenecks and input shortages stemming from Russia’s invasion of Ukraine.

This increased the prices of goods and services that households most noticed, reinforcing the severity of the price increase.

“We may be reaching a tipping point, beyond which an inflationary psychology spreads and takes root. This would mean 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 [é] less noticeable [e] also less relevant”.

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

Inflation has reached multi-decade highs in different economies, including the US, the eurozone and the UK. The BIS was concerned that major economies in North America, Europe and many emerging markets were close to a tipping point. Consumers had noticed price rises, large increases had become general in most goods, and falling real wages prompted attempts to recoup losses.

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

“As inflation rises and becomes a focal point for agents’ behavior, behavioral patterns tend to strengthen the transition,” he added, predicting that companies will struggle to prevent profit margins from being squeezed and workers will defend their salary.

The duration of most contracts would tend to shorten, he added, because parties on both sides could not guarantee future price levels.

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

“This values ​​a timely and decisive response,” the BIS advised member central banks, even though none of them was sure they had entered a high-inflation environment.

The BIS added: “The overriding priority is to avoid falling behind the curve, which would ultimately imply a more abrupt and vigorous adjustment. This would amplify the economic and social costs of controlling inflation.”

^{Translated by Luiz Roberto M. Gonçalves}