The Bank for International Settlements' Hyun Song Shin says a stabilising force is required in turbulent times

By Hyun Song Shin*

The global economy is at a crossroads. We have entered a new era of heightened uncertainty. Trade disruptions threaten to reshape the economic landscape, and long-standing relationships that have sustained global prosperity for decades are fraying.

Policymakers have a vital role to play as a stabilising force. Only consistent action on multiple fronts can maintain public trust and secure sustainable economic growth to benefit all of society. Trust is hard to win, but easy to squander.

Once they settle, trade tariffs are expected to be at levels unseen in decades, with serious implications for growth and inflation – and this in a world already grappling with significant challenges. Productivity growth has been persistently weak in many economies, public finances are fragile and financial vulnerabilities have built up.

Tariffs hurt both the targeted and the imposing country, raising prices and costs, dampening growth and creating uncertainty that delays firms’ investment and hiring. Growth is expected to slow, significantly so in several countries.

The dynamics may well turn out to be more complex than economic textbooks foresee, making for tricky navigation. The global economy is not a collection of islands, but a dense web of interconnections among suppliers, customers, consumers and the relationships and financing that knit them together.

Activity straddles borders, with goods originating in one country passing through many hands before finding their way to supermarket shelves or car dealerships. Disrupting these supply chains could lead to new inflation surprises. And unravelling the strands of global finance could weaken the fabric of the global economy.

In our latest Annual Economic Report, we at the BIS see vulnerabilities – and remedies – on three broad fronts.

First, rising trade fragmentation adds to a cocktail of old and new structural challenges in economies. Declining productivity growth drags on dynamism, also dampened by ageing populations and less migration.

After the surprise of post-pandemic price rises, households and firms are much more sensitive to inflation. A recent BIS survey shows households are deeply scarred by Covid-era inflation. Another jump in grocery or energy bills would be like a spark to dry tinder. It’s a case of once bitten, twice shy.

Growth-oriented economic reforms are vital to increase the potential and competitiveness of economies without rekindling inflation. Only such reforms can lift the standard of living, improve economic well-being and give people a sense of security. This includes political decisions to take lasting measures such as public investment in infrastructure and human capital.

Another priority is to remove barriers to trade, which could help offset losses from the ongoing trade conflicts. Revamping existing regional trade arrangements or striking new ones has gained greater urgency.

Second, public debt levels have spiked above peacetime highs in many countries. For some, the cost of servicing that debt rivals spending on education, defence or public pensions, leaving them vulnerable to shocks that could push up inflation or lead to financial stresses, risking financial stability.

Putting public finances on a sustainable footing is key. For many countries, this means reducing large deficits and rebuilding buffers to have space to cushion future blows and reinforce structural reforms. Sound public finances inspire trust, in investors and the public at large, and enable long-term prosperity.

Third, recent decades have seen deep structural shifts in the global financial system. The new landscape has government bond markets and asset managers, rather than banks, at its core. And sovereign bond markets are set to grow even larger with expansive fiscal policies.

Their increasing footprint brings financial stability risks, not least as activity increasingly occurs in unregulated and lightly monitored corners of financial markets. More fundamentally, the rise of non-banks has strengthened financial connections across borders, as investment funds absorb the flow of sovereign bonds. The greater interconnections wrought by these changes have made it easier for financial shocks to be transmitted internationally, even among major economies.

The challenges call for a holistic approach by supervisors and regulators. For banks, adopting Basel III standards to strengthen regulation and boost resilience through effective supervision and proper risk management across regions is a must. For non-banks, this means regulating activities posing similar risks with similar stringency.

For central banks wrestling with prospects of slower growth and higher inflation, a key lesson from the pandemic is that inflation can spring up from unexpected quarters. Central banks need to deal with the immediate fallout while keeping top of mind the deeper weaknesses risking economic resilience.

Success will depend on maintaining public trust in policymakers’ capacity to act in the public interest. Price stability is difficult to achieve and even more so if public policies pull in opposite directions.

Trust in central banks’ commitment to price stability was decisive during the pandemic and now needs to serve as the flag for others to rally around. Regulators and governments should work closely with central banks to stabilise and secure the future, for the benefit of all.

*Hyun Song Shin is Economic Adviser and Head of the Monetary and Economic Department at the Bank for International Settlements.