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Debt Trap May Paralyze Central Banks

Debt Trap May Paralyze Central Banks Debt Trap May Paralyze Central Banks

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 official said late 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, Reuters reported.

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 toward target” for central banks, he said. “It would be desirable to use the additional room for maneuver 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 the entire 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 globalization are limiting the impact.

The bank's advice comes as the global economy has accelerated this year, while unemployment rates continue to fall across developed economies. Despite that, inflation rates across the Group of 20 largest economies have eased and stand at levels last seen in 2009, when the world was just starting to emerge from the sharp economic downturn that followed the global financial crisis.

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