Central banks risk losing public trust if they fail to bring down high rates of inflation found across the developed world, according to the boss of the body that advises them.
Agustín Carstens, the director of the Bank of International Settlements, said central bankers needed to maintain a tough stance against inflation or else risk a new generation of consumers who had never experienced rapidly rising prices losing faith in their independent role.
Speaking in Brazil, Carstens also warned that the recent run of bank failures seen in the US and the reckless use of cryptocurrencies could undermine trust in the financial system.
In an unusually hard-hitting speech, the BIS boss said he was concerned that governments would undermine political institutions by spending their way to prosperity, saying the likelihood was that an increase in government budgets would be self-defeating and contribute to inflation. “The consequences of the state abusing the privilege of issuing money can be disastrous,” he added.
Central banks should continue to fight inflation with high interest rates to maintain trust in their institutions, he said. “The trust gained can be lost if society doubts the central bank’s commitment to the objective of maintaining price stability. This is one of the reasons why the recent rise in inflation in virtually every country is a cause for concern, he added.
He said the knock-on effects of a loss of confidence can “result in severe financial instability, with very high costs for society in terms of economic growth, employment, inequality and wealth”.
Carstens, a former boss of Mexico’s central bank, did not name individuals or countries but appeared to have a harsh word for any politicians that questioned the independence of their central bank and the primary purpose to keep inflation low and stable.
Liz Truss was widely criticised for putting forward proposals when she was prime minister last autumn to curb the independence of the Bank of England.
Carstens’ comments are also likely to be seen as a shot across the bows of the UK’s central bank should it consider cutting interest rates before inflation has fallen for a sustained period.
The collapse of Silicon Valley bank and the merger of Credit Suisse with UBS after the former found itself in financial trouble must be avoided he said to maintain trust in the financial system, he said.
Though he warned that in many countries 50% of lending was managed by non-banks, including hedge funds and insurance companies, where regulation was weaker than the rules governing the banking system.
“The need for greater supervision and regulation of the non-bank sector has become more pressing in the light of recent episodes of instability,” he added.
“Instability stems from the sector’s interconnectedness with the traditional banking system and the tendency of different forms of non-bank intermediation to generate opaque and excessive leverage as well as substantial liquidity mismatches. Upsets in this sector can result in systemic financial crises.”
