THE financial counsellor and director of the International Monetary Fund (IMF) monetary and capital markets department Tobias Adrian is advising central banks to take decisive action to prevent inflation from becoming entrenched and keep expectations of future price increases in check.

“Interest rates might have to rise beyond what is currently priced in markets to get inflation back to target in a timely manner. This may entail pushing interest rates well above their neutral level. For advanced-economy central banks, clear communication is crucial to avoid unnecessary volatility in financial markets, by providing clear guidance about the tightening process while remaining data dependent,” Adrian stated.

Notably, many central banks have already significantly tightened policy especially in emerging markets. Adrian believes they should continue to do so — depending on individual circumstances — to preserve their inflation-fighting credibility and anchor inflation expectations.

The IMF official further noted that policymakers should tighten selected macro prudential tools to tackle pockets of elevated vulnerabilities (for example, to lean against the surge in house prices), while avoiding a broad tightening of financial conditions. He said striking the right balance is important, given uncertainties about the economic outlook, the ongoing monetary policy normalisation process, and limits on post-pandemic fiscal space.

“Policymakers will also face structural issues such as fragmentation in capital markets, which would have implications for the role of the US dollar. Payment systems face similar risks as central banks seek to establish their own digital currencies that are independent of existing international networks. Regulators will also be under pressure to narrow regulatory gaps to ensure integrity and protect consumers in the fast-evolving world of crypto assets,” Adrian pointed out.

At the same time, he stated that trade-offs between energy security (adequate, affordable supplies) and climate (regulatory mechanisms intended to increase oil and gas prices) are being laid bare as supply and price effects of international sanctions on Russia ripple across Europe and beyond.

“There may be some setbacks in the climate transition in the immediate future, but the impetus to reduce energy dependency on Russia could be a catalyst for change. Policymakers should, therefore, strive to honour commitments on climate and intensify their efforts to achieve net-zero targets, while taking additional appropriate steps to address energy security concerns,” he continued.

Adrian’s warning comes as the IMF said that global financial stability is at risk due to the ongoing war between Russia and Ukraine.

The IMF in its latest Global Financial Stability Report published earlier this week, the fund noted that financial stability risks have risen along many dimensions, although no global systemic event affecting financial institutions or markets has materialised so far.

The last financial crisis occurred in 2007-2008 after predatory lending targeting low-income homebuyers, excessive risk-taking by global financial institutions, and the bursting of the United States housing bubble culminated in a “perfect storm.”

On this occasion, the IMF has noted that the major concerns are the repercussions of the war which continue to reverberate globally.

The fund noted that the war will test the resiliency of the global financial system through various channels, including direct and indirect exposures of banks, nonbank financial intermediaries, and firms; market disruptions (including in commodity markets) and increased counterparty risk; acceleration of cryptoization in emerging markets; and possible cyber-related events.