The global economy finds itself at a critical juncture, marked by increasing uncertainty driven by trade disruptions and precarious public finances. Consistent, multifaceted policy actions are imperative to rebuild public trust and ensure sustainable, inclusive economic growth. The Bank for International Settlements (BIS) has underscored critical vulnerabilities including trade fragmentation, declining productivity, and escalating debt distress, calling for comprehensive reforms and robust financial regulation.
The global economic landscape is undergoing profound changes. We are entering an era defined by heightened uncertainty, where traditional trade relationships that have fostered global prosperity are unraveling. Policymakers face the formidable task of providing stability through consistent and coordinated efforts across various domains to sustain public trust and secure economic growth for all.
Current projections indicate that trade tariffs are settling at levels not seen in decades, which carries significant implications for global growth and inflation. Many economies are grappling with persistently weak productivity growth, compounded by the fragility of public finances. Tariffs, while seemingly targeting specific nations, inflict damage on both the imposing and the targeted countries. The intricate web of global supply chains, intertwined by relationships and financing, means that disrupting these connections can trigger unexpected inflation surges. Furthermore, any unravelling of the global financial fabric risks weakening the entire economic system.
In its latest annual economic report, the Bank for International Settlements (BIS) identified key vulnerabilities and proposed remedies across three broad areas:
Trade Woes: Trade fragmentation is exacerbating existing structural challenges. A decline in productivity growth is dampening economic dynamism, a trend further influenced by aging populations and reduced migration. Following the post-pandemic inflation surge, households and businesses have become acutely sensitive to price increases. A recent BIS survey reveals that the inflation experienced during the Covid era has left a lasting impression on households, suggesting that any new rise in essential costs, like groceries or energy, could quickly ignite broader inflationary pressures.
To counter these trends, growth-oriented economic reforms are essential. These reforms aim to boost the potential and competitiveness of economies without generating excessive import demand or reigniting inflation. Such measures are crucial for improving living standards, enhancing economic well-being, and providing a sense of security to citizens. This includes critical political decisions to implement long-term public investments in areas like infrastructure and human capital. Additionally, removing trade barriers is a priority, as it could help mitigate the losses incurred from ongoing trade conflicts. The urgency to revamp existing regional trade agreements or forge new ones has never been greater.
Debt Distress: Public debt levels in numerous countries have surged to post-peacetime highs. For some nations, the cost of servicing this debt is comparable to, or even exceeds, spending on vital sectors such as education, defense, or public pensions. This leaves these countries highly vulnerable to shocks that could lead to inflationary spikes or severe financial stresses, thereby jeopardizing financial stability.
Establishing sustainable public finances is paramount. For many countries, this means implementing measures to reduce large fiscal deficits and rebuild financial buffers. Such actions are necessary to create fiscal space to absorb future economic shocks and to reinforce structural reforms. Sound public finances foster trust among investors and the general public, laying the groundwork for long-term prosperity.
System Flaws: Recent decades have witnessed significant structural transformations within the global financial system. The current landscape is increasingly centered around government bond markets and asset managers, rather than traditional banks. This shift is further amplified by expansive fiscal policies, which are expected to lead to even larger sovereign bond markets.
The growing influence of these market segments introduces financial stability risks, particularly as an increasing proportion of activity occurs in less regulated and less transparent corners of financial markets. Crucially, the rise of non-bank financial institutions (NBFIs) has strengthened cross-border financial linkages, as investment funds absorb the increasing flow of sovereign bonds. The heightened interconnectedness resulting from these changes facilitates the international transmission of financial shocks, even between major economies.
Addressing these systemic challenges requires a comprehensive approach from supervisors and regulators. For banks, strict adherence to Basel III standards is vital to fortify regulation and enhance resilience through effective supervision and sound risk management across all regions. For non-banks, the principle should be to regulate activities that pose similar risks with comparable stringency.
Central banks, contending with the twin challenges of slower growth and higher inflation, have learned a key lesson from the pandemic: inflation can emerge from unexpected sources. They must manage the immediate consequences while concurrently addressing the underlying weaknesses that threaten economic resilience. Success hinges on maintaining public trust in policymakers' commitment to acting in the public interest. Achieving price stability is inherently difficult, and becomes even more so when public policies are contradictory.
During the pandemic, trust in central banks' commitment to price stability was a decisive factor, and this trust must now serve as a rallying point for other policymakers. Regulators and governments should collaborate closely with central banks to stabilize and secure the economic future for the benefit of all.
