Rising supply shocks, driven by deglobalization and climate change, may demand tighter monetary policies
Supply shocks in the global economy could become more frequent, according to Financial Post.
Central banks may need to adjust their monetary policies in response, as warned by the Bank for International Settlements (BIS).
“The economic landscape may well be changing, featuring greater risk of adverse supply shocks and less elastic supply,” said BIS deputy manager Andréa Maechler during a speech at the London School of Economics.
She emphasized that central banks may need to change their approach to monetary policy, especially in the face of inflationary supply and demand shocks. “Looking through supply shocks will not always be possible,” Maechler added.
Maechler explained that changes in geopolitics, trade, demographics, and the green transition are creating new risks to the inflation outlook. She pointed out that stronger monetary tightening might be necessary at times to keep inflation expectations anchored.
Reflecting on the inflation crisis of 2022, Maechler acknowledged that many central banks were slow to act by raising interest rates.
“With the benefit of hindsight, some have argued that central banks in many advanced economies were slow to react to the initial burst of inflation, anticipating that they could look through it because it would be transitory,” she said.
Several supply shocks from the inflation crisis have not yet eased. Maechler noted that energy prices remain well above pre-pandemic levels in many countries, and labour markets have undergone significant changes, with uncertain long-term impacts on supply and productivity.
In addition, demographic trends are altering the dynamics of labour markets. Maechler pointed out that declining birth rates in advanced economies are leading to a shrinking working-age population, especially as the baby boomer generation retires.
“As these demographic trends turn, workers’ bargaining power might increase, potentially generating greater resistance to downward pressures on real wages or even bringing back indexation mechanisms and leading to wage-price spirals,” she warned.
Deglobalization is also posing new challenges, as Maechler noted. She suggested that if this trend continues, it may reduce countries' ability to use international trade to alleviate domestic supply constraints.
“If deglobalization trends take hold, they would weaken the scope for international trade to act as a shock absorber of domestic inflationary pressures,” she said.
Maechler also warned that the transition to green technologies could be bumpy and may cause disruptions until investments in these technologies reach a large enough scale.
She highlighted that climate change is already affecting food prices, noting that rising global temperatures and more frequent extreme weather events could make food prices more volatile.
“Food prices could also become more volatile due to rising global temperatures and more frequent extreme weather events,” Maechler said.
She recalled that in 2022 and 2023, high temperatures and droughts in southern Europe, coupled with heavy rains in northern Europe, contributed to a spike in food prices. Both advanced and emerging market economies could face further shocks as a result of these environmental factors.
