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London (Reuters): Central banks are in danger of falling into a “debt trap” where they can’t take needed action for fear of triggering defaults and economic turmoil, a senior Bank for International Settlements (BIS) official said on Friday.
In a speech in London, Claudio Borio, the head of the monetary and economic department at the central bank umbrella group, said it may be time for central banks to focus less on inflation and more on financial stability.
Low interest rates are encouraging record amounts of borrowing – as is the asset-buying stimulus employed by many central banks seeking to lift inflation.
But such policy in turn makes central banks more nervous about raising interest rates in case it sends their borrowers to the wall and causes a slump in their economies – known in economic textbooks as a debt trap.
“At a minimum, this suggests lengthening the horizon over which it would be desirable to bring inflation back towards target,” for central banks, he said.
“It would be desirable to use the additional room for manoeuvre to address the financial cycle more systematically.”
“This could improve overall macroeconomic performance and reduce the risk of a ‘debt trap.’ A trap could arise if policy ran out of ammunition, and it became harder to raise interest rates,” Borio said.
He added that his remarks had been intentionally provocative.
“We may need to adjust monetary policy frameworks,” he said, highlighting “the desirability of greater tolerance for deviations of inflation from point targets while putting more weight on financial stability.”
Despite all the stimulus from loose monetary policy, inflation has remained stubbornly low in many places.
Borio said economists should not overestimate the ability of central banks to fine-tune inflation, especially in the current environment where new technologies, working practices and globalisation are limiting the impact.
