States must maintain targeted and temporary fiscal spending, as widespread and persistent stimulus measures could increase inflationary risks and force central banks to raise interest rates, said the CEO of the Bank for International Settlements (BIS) during an interview with the Japanese daily Nikkei.
Prolonged disruption in the Middle East could also threaten global financial stability, as rising public debt over the past 15 years is increasingly mediated by non-bank financial institutions, including highly leveraged hedge funds, a said Pablo Hernandez de Cos, director general of the BRI.
‘In recent weeks, market sentiment has been driven by optimism surrounding developments in artificial intelligence (AI) and hopes for a rapid resolution to the conflict in the Middle East. If these expectations turn out to be wrong, I easily anticipate a risk of brutal market corrections,’ he said in the interview published Monday.
The war in the Middle East has increased volatility on world markets and prompted certain countries, including Japan, to increase their spending to cushion the economic shock linked to the surge in oil prices.
However, the energy shock has also increased pressure on certain central banks to raise their rates in order to combat the risk of excessive inflation, even if it means slowing down economic growth.
Central banks should ‘ignore’ a temporary negative supply shock if it does not destabilize inflation expectations or trigger damaging second-round effects, Mr. de Cos said.
But if the shock persists, such an approach would become less tenable, he added, specifying that the memory of the post-pandemic inflationary surge could increase the risk of second-round effects.
‘Central banks should carefully monitor these developments and be ready to act if necessary,’ the Nikkei reported, quoting Mr. de Cos.
‘Fiscal support must be targeted and temporary. If it becomes broader and more persistent, inflationary risks increase considerably, potentially forcing central banks to raise interest rates, which, in turn, would weigh on economic growth,’ he added.
Mr. de Cos refused to comment on press reports citing him among the potential candidates to succeed the President of the European Central Bank, Christine Lagarde.
