By Marc Jones
LONDON (Reuters) - The head of the Bank of International Settlements has warned that years of fighting economic crises have created conditions that are pushing the limits of stability when it comes to the international financial system.
Agustín Carstens, general manager of the BIS, which is dubbed the central bankers' central bank, said this "region of stability" was not defined by interest rates, or debt levels, but instead influenced over time by political and technological forces and macroeconomic policies.
Central bankers around the world have been hiking interest rates to battle inflation. However, in a speech at Colombia University in New York, Carstens said that to avoid a long-term "high-inflation regime" rates may need to stay higher and for longer than previously thought, even at the expense of slowing down economies.
Debts piled up during the global financial crisis and more recently the COVID-19 pandemic, are making the central banks' task more complex too.
Some are already seeing political pressure to slow rate hikes to ensure the cost of servicing that debt does not spiral.
They are also facing large losses - on paper at least - on the trillions of dollars, or euros, worth of bonds they bought to try to boost their economies during crises, meaning that governments are also no longer getting a share of the profits those purchases once generated.
"These risks are material," Carstens said.
Another major challenge is financial instability. Since the 1970s, in close to one fifth of cases, banking stress has broken out roughly three years after the start of a coordinated global interest rate hiking cycle.
Larger increases in inflation and higher levels of private sector debt make stress ever more likely, Carstens added, noting that this was the first time since the Second World War where a major surge in inflation has come when debt levels are so high.
It also means policymakers should alter their approach going forward and refrain from aggressive rate cuts, or stimulus, when inflation settles below targets.
That should help limit the negative side effects of ultra-low interest rates, most notably the build-up of the kind of financial vulnerabilities that have been seen recently in the banking system.
Central bank independence should be enshrined and mechanisms to encourage prudent fiscal policy should also be given greater bite, Carstens said.
"A shift in policy mindset is called for," the former Mexico central bank governor said. "Returning firmly inside the boundaries of the region of stability should be a conscious and explicit policy consideration."