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The IMF is sceptical about the current situation. Central banks should focus on fighting inflation.

Jessie Ramsdale
18. 4. 2023
5 min read

In recent years, the global financial system has faced its first significant test of stability since the global financial crisis in 2008. This test is rooted in several major problems, notably rising inflation, which threatens to destabilise economies around the world, and banking crises in the US and Europe.

Inflation has become a key issue for central bankers, who are now considering whether they should adjust their monetary policy to better control inflation. In the euro area and the US, inflation is well above central bank targets, which may lead to higher interest rates and tighter financial conditions. This rise in inflation has been triggered by several factors, including prolonged low interest rates, which increase the vulnerability of economies. Monetary policy may thus focus on fighting inflation in the future.

There is certainly a risk of rising interest rates and a risk of rising inflation.

According to the Director of the IMF's Monetary and Capital Markets Department, there is still a risk of rising interest rates, leading to a recommendation for central banks to stay the course on tightening until there is significant progress in returning inflation to target. The problem is that an increase in interest rates may have a negative impact on economic growth and may worsen the debt situation of some countries.

The International Monetary Fund (IMF) has warned of the risks of tighter monetary and financial conditions and estimated a reduction of about 0.5% of GDP due to the tightening in March after the bank collapse. The IMF also slightly lowered its outlook for global growth this year to 2.8%, pointing out that the financial system could face further problems if inflation is not tamed and banking crises are not dealt with effectively.

The risks to financial stability have so far been contained and hopefully will remain so, as a result of which monetary policy can focus on fighting inflation, and this is a desirable outcome.

Banking problems appear to be limited for now, but their impact on global financial stability should not be underestimated.

I think that systemic risk has been contained so far and I am confident in the crisis management toolkit that we have, but I would not be surprised if there were further episodes of turmoil in both banks and non-bank financial intermediaries.

Central banks and governments should, in the IMF's view, take coordinated action to address the current problems in order to avoid a wider damaging impact on economies.

Measures that could be considered include increasing capital requirements for banks, encouraging debt restructuring and strengthening financial regulation. These steps could help improve confidence in the banking sector and reduce the risk of further banking crises.

One important aspect of tackling inflation is to increase transparency and communication between central banks, governments and the public. Regular updates on monetary policy and inflation targets can help reassure markets and ensure that the public is informed about the reasons for changes in monetary policy.

In addressing these issues, it is also important to take into account the global nature of the current challenges. Advanced economies should work with developing countries to ensure that monetary policy and financial regulation work for global stability.

In the current situation, it is also important to keep an eye on other potential risks, such as global trade tensions or geopolitical tensions, which could lead to further financial shocks and worsen the overall situation. Governments and central banks should be vigilant and prepared for any new challenges that could threaten global financial stability.

Given these threats and uncertainties, central banks should consider a more flexible approach to monetary policy. In practice, this could mean that central banks should be willing to react quickly to changes in economic conditions and adjust their policy as necessary to achieve their inflation targets and safeguard financial stability.

International cooperation and coordination between central banks and governments should be a priority in order to achieve common goals and ensure global financial stability. This may include cooperation on information exchange, monetary policy coordination and joint regulation of financial institutions.

Governments should also use fiscal policy to promote growth and stabilise economies. This could include sensible spending on infrastructure, education and research and development, which could help boost productivity and support growth. Fiscal policy should be designed to be sustainable and take into account long-term fiscal challenges such as ageing populations or rising debt.

In the area of financial regulation, reforms should be introduced to increase the resilience of the financial system to shocks and reduce the likelihood of future crises. This could include improving bank supervision, strengthening macro-prudential measures and improving the regulation of financial markets.

In conclusion, the current global financial challenges require a coordinated and proactive approach by central banks, governments and international organisations such as the IMF. Significant progress in tackling inflation, resolving banking crises and strengthening overall financial stability will be key to sustaining global growth and minimising the risk of recession in the coming years.

WARNING: I am not a financial advisor, and this material does not serve as a financial or investment recommendation. The content of this material is purely informational.


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