World on Threshold of New Inflationary Era, Warns BIS Head

Food prices are at the highest they have been in almost 18 years. The Government may now reject calls to cut GST on food. (Matt Cardy/Getty Images)

After struggling for over a decade to bring inflation up to their target rates, central banks of the world are now faced with the inverse problem—rising inflation, Agustín Carstens, General Manager of the Bank for International Settlements (BIS), said in a speech at the International Center for Monetary and Banking Studies on April 5.

“A key message is that we may be on the cusp of a new inflationary era. The forces behind high inflation could persist for some time. New pressures are emerging, not least from labor markets, as workers look to make up for inflation-induced reductions in real income. And the structural factors that have kept inflation low in recent decades may wane as globalization retreats,” Carstens said in his speech (pdf).

“Almost 60 percent of AEs [advanced economies] currently have year-on-year inflation above 5 percent—more than 3 percentage points above typical inflation targets. This is the largest share since the late 1980s … In more than half of EMEs (emerging market economies), inflation rates are above 7 percent.”

No one should expect inflationary pressures to ease anytime soon, Carstens warns. As challenges like the COVID-19 pandemic, semiconductor shortages, and shipping disruptions continue to persist, the full impact of price disruptions in 2021 might still be “working its way through the system,” he said.

In addition, new inflationary pressures have also popped up. Since Russia’s war on Ukraine in late February, the prices of food, oil, and other commodities have soared as supplies dwindled. These will “feed directly” into higher consumer prices.

Inflation expectations are becoming “unmoored.” Many experts are forecasting inflation of over 4.5 percent in the United States and much of Europe over the next two years, he said. In many other AE’s, inflation is expected to be above 3.5 percent.

According to Carstens, policymakers will have to “shift their mindsets” to adapt to the new economic environment. “It seems clear that policy rates need to rise to levels that are more appropriate for the higher inflation environment. Most likely, this will require real interest rates to rise above neutral levels for a time in order to moderate demand.”

The adjustment to higher interest rates “will not be easy,” as conditions in several countries “complicate matters,” the BIS chief said. Households, sovereigns, and financial markets have become “too used” to low interest rates.

An expansionary monetary or fiscal policy is not the key to higher sustainable growth. Instead, nations must focus on strengthening the “productive capacity” of their economies, he stressed.

Carstens’ assessment comes as inflation is soaring in the West to record levels. Inflation in the United States is at its highest level in almost four decades. In the UK, inflation rates are at their highest in 30 years while in the Eurozone, inflation rose to its all-time high in March at 7.5 percent.