The global economy is in danger of entering an era of high inflation with the threat of stagflation looming. While that might sound like a report from the 1970s, it is the latest assessment of the Bank for International Settlements (BIS) about the global economy in its 2022 annual report. These threats stem from a combination of ongoing disruptions from the pandemic, the war in Ukraine, rising commodity prices, and financial vulnerabilities.

The priority for central banks is restoring low and stable inflation. In doing so, central bankers should seek to minimize the impact on economic activity and thus preserve financial stability. Such a «soft landing» has proven difficult in the past, and today's initial conditions make it a challenge, the central bank umbrella organization warns.

Unprecedented Situation

High debt levels coupled with overvalued asset prices make the central banks' task more difficult and increase the risk of a financial crisis. In an interview with «Handelsblatt» (in German, behind paywall), Claudio Borio, head of the Monetary and Economic Department, explains: «We are dealing with a situation unprecedented since the Second World War. It's a combination of high inflation, which requires monetary tightening, and vulnerabilities in the financial system, such as very high debt and years of soaring real estate prices.»

There have certainly been periods of high inflation in the past such as in the 1970s, leading to recessions as central banks tightened rates to combat soaring prices. Moreover, there have been crises in the financial system that have had the same effect. «But there was no such thing as both happening at the same time,» explains the BIS chief economist.

Not 1970s Redux

Asked whether he sees a way to lower inflation without triggering a recession, Borio finds, «It depends very much on country-specific circumstances.» In the US, he says, inflation is mainly due to very strong demand and economic activity. The eurozone and the UK, on the other hand, are heavily dependent on energy and commodity imports, he said, meaning price increases lead to a large loss of income, dampening growth.

So is a 1970s-style copy of stagflation now looming? «The situation is not the same. Economies are less dependent on oil than in the past, and the inflation shock is smaller,» Borio says. Central banks are more aware of what they need to do, he adds. But conditions are very difficult, he says. «It's a fine line,» he comments.

Scolding for Crypto

Public sector debt, at its highest level since World War II, presents another set of problems, the BIS chief economist says. «If interest rates were to go back to the levels of the mid-1990s, which was a reasonable level, then the burden of servicing debt would rise to an all-time high. So governments will feel the impact of central bank rate hikes.»

Last week, the BIS had already published a special chapter from its annual report in advance. In it, the organization made it unmistakably clear that it sees the future of money in digital central bank money (CBDC) - and not in cryptocurrencies like Bitcoin and others. 

«As dramatic as the recent price falls have been, focusing on price developments alone diverts attention from the deeper structural deficiencies of cryptocurrencies that make them unsuitable as the basis for a monetary system that serves society,» the BIS judged.