While high food and energy prices curb consumption on these products, they would also encourage investment and increase supply in the long-term. In short, the common view is that central banks have nothing to do but wait for the supplydriven shocks to work out their natural course. However, in the current environment where persistent and rapid increases in food and energy prices have been observed for a considerable period, the prevalence of this view has become questionable – especially in the light of current projections that foresee even higher prices in the near future. As a matter of fact, many countries under inflation targeting regime now project that inflation will converge to the target at the end of 2009 or in 2010, at the earliest. Going through a long period of high inflation is a serious risk for price stability. First, the general price level may shift upwards at a faster rate, as producers and workers in other sectors ask for higher prices and wages in response to the loss of their real purchasing power. The fall in real interest rates due to deterioration in inflation expectations is another risk, since lower real rates will lead to a faster pace of credit expansion. The common factor of these two risks is that persistent supply shocks may turn into demand shocks after a while. Thus, at some point, central banks have to decide to what extent they can tolerate the rise in inflation.
Let me explain why the subject is a very timely and relevant topic. War and peace: Rising government debts in developed countries since 1980s 5. During World War II, naturally most governments borrowed huge amounts of debts to finance the warfare. As a result, the public debts shot up and the ratio of public debt to GDP rose to very high levels. In the industrial nations (e.g. US, UK, France, Germany and Japan), the average government debt increased to a peak level of over 200% of GDP in 1946. Huge government borrowings had crowded out the private sector and in any case most industries not related to military supplies production did not have the opportunity to expand their business anyway. After the War, industrial nations began to pay down their public debts as they embarked on the journeys of reconstruction. BIS central bankers’ speeches  1  6. After two decades of hard work and economic growth, the ratios of government debt to GDP of the industrial nations came down to below 30% in the 1970s while private sector debts grew steadily to around 85% of GDP. The total debt, public and private combined, was amounting to 110% of GDP at that time. 7. A brief word about debt. When one borrows money, whether to fund investments or to finance consumption, it could bring about many beneficial effects. For example, student loans could assist many young people without the necessary means to take up education or training that would benefit their whole lives.