Source: Bank for International Settlements
Good morning, ladies and gentlemen.
Thank you for joining us at this pivotal moment for the global economy. As we gather here today, we find ourselves at a crossroads – one shaped by challenges that are both immediate and structural. At the same time, we also have opportunities to reshape and improve our monetary and financial systems.
Just a few months ago, the near-term outlook for the global economy was favourable. After the Covid-19 pandemic and a struggle to restore price stability, a soft landing was finally in sight.
But, as history has shown us time and again, stability can be elusive. In early April, larger-than-expected tariffs were announced by the US administration. This fraying of long-established economic ties came on top of other policy ruminations in the United States that stoked concerns about policy direction and stability.
These events jolted the global economy. Asset prices swung wildly. Growth forecasts were cut.
The global economy entered a new era of heightened uncertainty and unpredictability.
Yet, with the benefit of hindsight, it is clear that the global economy faced serious challenges even before these tumultuous events. Productivity growth has been persistently weak in many economies. Fiscal positions are fragile. Financial vulnerabilities have built up, often in opaque ways. These challenges are compounded by the threat to prosperity from active conflicts on multiple continents.
So, where do we go from here? How do we navigate these turbulent waters?
Trust and policy
Let me begin by emphasising a principle that lies at the heart of successful public policy: trust.
Trust in public institutions, in central banks and in the very foundation of our economic systems – money itself. Today, as we face new uncertainties, this trust remains essential. It is the bedrock upon which economic stability is built.
Trust cannot stop at monetary policy and the door of the central bank. It must extend to every aspect of public policy. People must trust that policymakers and elected officials will act to advance legitimate objectives and will do so effectively. They must trust that the foundations of our economic systems are sound. And they must trust that innovation will be used to benefit society, not merely disrupt it.
This year’s Annual Economic Report reflects on these important themes. It reviews the state of the global economy, examines the key policy challenges and takes a closer look at two critical issues: how financial conditions are determined in today’s evolving global financial system and how the future monetary and financial system will be designed.
From soft landing to turbulence and uncertainty
In early 2025, the global economy appeared to be on track for a soft landing. Inflation was either on target or converging to central bank targets. Labour markets had largely normalised. The global economy was expanding at a respectable pace. And the mood in financial markets was growing more upbeat. To be sure, challenges were on the horizon for policymakers. But it seemed, for a moment, that the worst was behind us.
The outlook has since darkened. The announcement of broad-based US tariffs sent shockwaves through markets. Trade policy changes have been accompanied by the prospect of an ambitious fiscal expansion, questioning of central bank independence, discussions about penalising foreign holders of US securities and challenges to the legal system, among others. The repeated cycle of announcements, adjustments and reversals has fostered an atmosphere of uncertainty and unpredictability.
The market reaction was telling. Volatility soared. The US dollar depreciated even as government bond yields rose – an extraordinary, troubling combination. These unusual dynamics led to speculation in some quarters about the US dollar’s long-standing safe haven status.
Some of the more extreme policy changes that triggered market reaction seem to have been walked back. This has prompted a recovery in markets. But there is still very little clarity about the eventual scope of trade and other key policies amid the daily flow of ruminations.
Reverberations will make their way through the global economy, amplifying existing vulnerabilities. The full impact will take time to show.
Tariffs remain at levels not seen in decades and will exert pressure on both output and inflation.
In the meantime, elevated uncertainty may already be taking a toll. Firms are reporting delays in their hiring and investment decisions.
Past bouts of uncertainty have typically been followed by weaker economic activity and, in particular, business investment. Consistent with this, growth forecasts have been revised downward. Confidence indicators point to deteriorating economic activity.
Structural vulnerabilities in a shifting world
The recent turbulence has exposed and amplified long-standing vulnerabilities in the global economy. These include structurally low economic growth, unsustainable fiscal positions amid historically high public debt and the growing footprint of less regulated non-bank financial institutions (NBFIs). In combination, these developments make economies less flexible and less resilient. Policy is less able to respond when needed. And markets are more fragile and more likely to propagate risk.
Rising trade fragmentation is particularly concerning. Globalisation has been a vital force in sustaining income growth. It has also facilitated technological diffusion through foreign direct investment, especially among emerging market economies. But growth in global trade slowed considerably after the Great Financial Crisis. The recent imposition of tariffs could intensify this trend.
Tariffs are often justified as tools to address trade imbalances or protect domestic industries. Past experience tells us that they will not achieve these goals. Instead, they risk reducing economic growth further and exacerbating inflationary pressures. They will also make aggregate supply less flexible and economies more inflation-prone.
The global economy is becoming less resilient to shocks. Population ageing, climate change, geopolitical tensions and a less elastic supply side all contribute to a more volatile environment. Inflation expectations, already scarred by the pandemic, might be less firmly anchored. Households and firms, having been surprised by the persistence of inflation in recent years, might now be more sensitive to price changes.
To address these challenges, structural reforms are essential to make aggregate supply more nimble. Policymakers must focus on three key areas: bolstering labour and product market flexibility, reducing barriers to trade and enhancing public investment. These reforms will not only strengthen economic resilience but also lay the groundwork for sustainable, long-term growth.
The burden of debt
High levels of public debt are a significant vulnerability that governments can no longer ignore. Since the Great Financial Crisis, public debt has reached levels near or exceeding peacetime highs in many countries. While high debt can be sustainable when growth is robust and interest rates low, today’s conditions are far less supportive.
Rising interest payments, driven by higher rates and refinancing needs, are putting pressure on fiscal accounts and increasing fiscal sustainability risks. Already, there are signs of weakening investor appetite for government bonds and rising intermediation challenges. The absorption of debt issuance, particularly at longer tenors, has proved difficult on occasion. High debt may increase political pressures on central banks to keep interest rates lower than warranted by developments in inflation and output.
High debt makes the financial system more vulnerable. Repricing of government debt can lead to losses for banks and NFBIs, tightening financial conditions and dampening economic activity.
To minimise these risks, maintaining a credible and sustainable fiscal policy framework is critical. For some countries, this will require fiscal consolidation. For all, it will mean improving the “quality” of fiscal policy to make it growth-friendly.
Fiscal authorities need to build capacity to confront future shocks. This will allow them to support the economy when required, and it will ease the pressure on monetary policy to be a source of sustained growth.
The evolving financial landscape
The global financial system has undergone profound changes in recent years.
Two structural changes, in particular, stand out. The first is the shift in underlying claims from those on private sector borrowers to claims on the government. The second structural change is the shift in the source of funding from banks to NBFIs.
The increasingly central role of NBFIs introduces new risks and challenges, including for banks. While NBFIs have brought innovation and diversity to financial markets, they are also more opaque and less regulated than traditional banks.
The growth of private credit markets, for example, raises questions about credit quality and resilience in the face of economic downturns. A growing share of the long-term credit to small or medium-sized and highly indebted companies is now provided by private credit funds. While this has brought a range of benefits, we need to recognise the risks. The resilience of this young sector to a sizeable downturn in the credit cycle remains largely untested.
Similarly, the greater role of alternative asset managers and hedge funds in key financial markets has raised the likelihood that financial instability could be amplified by liquidity stresses. NBFIs have facilitated the funding of governments, but often with financial engineering that can be fragile. Their complex leveraged positions are vulnerable to adverse shocks, as we have seen in recent years and will likely see again. This deterioration in market function has increased the likelihood of financial stress episodes triggering central bank intervention. Stablecoins, while still small, are also gradually emerging as another potential source of liquidity risk.
Banks interact with the NBFI ecosystem through several channels. For example, banks provide liquidity to private credit funds through subscription lines, offer credit lines to hedge funds and collaborate in the securitisation of leveraged loans. Meanwhile, banks’ intermediation in repo and foreign exchange swap markets facilitates the growing footprint of internationally active NBFIs.
We know that even safe, liquid claims can be at the centre of a stress event, with potential spillovers that tighten financial conditions for the real economy. These risks to the safety and soundness of the banking system need to be carefully monitored.
Together, these developments have heightened the sensitivity of financial conditions to global risk factors. Emerging market economies have long experienced the spillovers of financial conditions from advanced economies. As Hyun will discuss shortly, major advanced economies increasingly figure in the transmission of financial conditions, both as the originators and as the recipients.
To address the risks presented by a larger NBFI sector, regulators must adopt a holistic approach. Banking and non-banking activities that pose similar risks should be subject to similarly stringent regulatory standards. Regulatory measures could entail a mix of activity-based and entity-based regulatory controls. This will help prevent the build-up of systemic risks and minimise competitive distortions among different providers of financial services.
Central bank priorities
Let me now turn to central bank priorities.
As they face these new challenges, central banks can draw on the valuable lessons learned in recent years. The pandemic era has reminded us that inflationary pressures can arise from multiple sources, not just strong demand. Structural shifts and supply side rigidities mean that economic shocks may now have a larger and more lasting impact on inflation. The recent inflation surge has left scars on inflation expectations, making the role of independent central banks as trusted anchors of price stability more important than ever.
Trade tensions exemplify the challenges central banks face. For some economies, recent developments will resemble a stagflationary shock. As such, they present a difficult trade-off for monetary policy. Central banks must carefully balance supporting growth and employment with preventing temporary price increases from turning into persistent inflation. Households, in particular, may show less tolerance for price increases and real wage declines following the sharp rise in living costs after the pandemic. If evidence of de-anchoring emerges, central banks must respond quickly and forcefully to inflationary shocks. The uncertainty surrounding the timing, magnitude and future trajectory of tariffs further complicates this task.
Countries that have not imposed tariffs or retaliatory measures are likely to face something more akin to an adverse demand shock. As a result, the disinflationary effects in these economies, including from lower prices for goods, are likely to dominate. Economies in this group, particularly those where inflation is low, may therefore have greater room to continue supporting growth with monetary easing.
For all central banks, three key lessons from the experience of recent years stand out. First, while inflation targeting should be symmetric, central banks should pay particular attention to preventing large inflation surges. Second, agility is key. Central banks must prioritise flexible tools, use balance sheets cautiously and rely on macroprudential measures to bolster financial system resilience. Third, humility is vital. Unexpected developments will happen. The use of alternative scenarios could help communicate the extent of uncertainty economies face. Scenarios do add complexity, but they can help clarify the central bank’s reaction function, thus helping households and businesses to navigate uncertainty and aligning their expectations.
By staying true to their mandates and adapting to evolving circumstances, central banks can continue to anchor expectations and foster stability in an unpredictable world. This is the path to maintaining trust and contributing to sustainable economic growth.
Building a monetary and financial system for the future
Finally, let me turn to the future of the financial system. Digital innovation offers many promises. For one, technologies such as artificial intelligence should be part of the solution for monitoring financial market risks such as those arising from the growing heft of NBFIs. More importantly, digital innovation offers immense potential to transform the monetary and financial system. Technologies like tokenisation and programmable payments hold the promise of faster, more secure and more efficient transactions.
Innovation must be guided by trust. Central banks have a critical role to play in ensuring that the foundations of the monetary system remain sound. This includes building on top of the two-tier system with central bank and commercial bank money at its core, providing regulatory frameworks, fostering public-private partnerships and articulating a clear vision for the future.
By contrast, alternatives built on privately issued currencies, including stablecoins, fall short when set against the three key tests that money must fulfil to serve society. The first is the singleness of money, which is the acceptance of money at par with no questions asked. The second is elasticity, the ability to flexibly meet the demand for money. The third is the integrity of the monetary system against illicit activity.
At the BIS, we have been working to shine light on developments in technology that may be harnessed by central banks. Major innovations like the entry of big tech into finance, central bank digital currencies and artificial intelligence are challenging and reshaping the financial system. Through the Annual Economic Report, we have worked – for each of the past eight years – to support the central banking community in understanding how to harness these innovations while preserving trust in money. This year’s chapter is in line with these efforts. We envision a next-generation monetary and financial system centred around a trilogy of tokenised central bank reserves, commercial bank money and government bonds. This system can set the stage for further innovation. It could enable seamless, automated transactions, reducing frictions and unlocking new possibilities for commerce and finance globally.
Conclusion
The challenges we face are formidable, but they are not insurmountable. By addressing structural vulnerabilities, maintaining trust in our institutions and embracing innovation, policymakers can help build a more resilient and inclusive global economy.
Let us grasp this moment to lay the foundations for a better future – one that is defined not by uncertainty and fragmentation, but by stability, cooperation and shared prosperity. In times of great uncertainty, central banks can play a vital role as a stabilising force delivering on their mandates with the public interest and stability at the heart of policy decisions. This will foster trust and ensure the success of the policy response, for the benefit of all.
Thank you.