Policymakers need to abandon the illusion that they can use monetary and fiscal stimulus to engineer economic growth without stoking inflation or breeding financial instability, the head of the Bank for International Settlements has warned.
Agustín Carstens, general manager of the BIS, an umbrella body for central banks, called on Monday for governments and central banks to stop seeking quick fixes to boost the economy every time recessions hit or growth faltered, and instead embrace the need for deeper reforms.
“To generate resilient and sustainable growth, there is no alternative to working on the supply side of the economy. Structural reforms are politically difficult, we know. But we also know that there is no free lunch,” he said at an event at Columbia University in New York.
Carstens argued policymakers were in large part to blame for the inflationary crisis, saying the vast stimulus deployed during the Covid-19 pandemic had fuelled demand while supply was artificially constrained.
“With the benefit of hindsight, it is now clear that policy support was too large, too broad and too long-lasting,” he said. But this was simply the culmination of a long period in which policymakers had run the economy too hot. “Quiescent inflation fostered the belief that monetary and fiscal policy could smooth out every economic downturn and prolong expansions with little constraint,” he said.
He also said rising public debt, coupled with low-for-long interest rates, was the “root cause” of recent episodes of financial stress — such as the collapse of Silicon Valley Bank, and the UK turmoil around pension funds.
The immediate priority now was to restore price stability, Carstens said, and this could mean interest rates needed to stay higher for longer even if governments felt the pinch as debt service costs rose.
“There is no time to lose. The longer inflation lasts, the more likely is a shift to a high inflation regime,” he warned.
Carstens’ comments echoed recent calls from the IMF for governments to rein in borrowing more quickly, in order to help central banks battle high inflation and financial instability.
“Fiscal policy will also have to play its part,” he said, arguing that by reining in spending, governments could dent demand. That would limit the risks of financial turmoil as further rises in borrowing costs would not be necessary. It would also leave governments with more firepower if they needed to intervene in a solvency crisis
Vítor Gaspar, head of fiscal policy at the IMF, made similar arguments at the fund’s annual gathering in Washington last week, warning that the US and China were driving a risky increase in the world’s public debt burden.
Carstens said that beyond the immediate fight against inflation, the bigger challenge would be to put both monetary and fiscal policy on a more stable footing, by moving away from the ultra-loose settings of recent years and giving policymakers more room for manoeuvre when shocks came.
This could mean being more tolerant of persistent shortfalls of inflation from central banks’ targets, he said — because this would reduce the need to keep interest rates unusually low for long periods, and would therefore limit the associated side effects of risks building up in the financial system.
It would also mean doing more to stop governments overspending, through the design of fiscal rules and by giving independent fiscal councils “greater bite”.