From resilience to robustness?
The past year saw investment in artificial intelligence (AI) ecosystems help global growth to withstand the blow from major tariff hikes. Yet geopolitical headwinds and rising fiscal and financial fragilities remain. Reinforcing the foundations of effective macroeconomic and financial policies is increasingly critical. Such foundations include fiscal sustainability, an unambiguous commitment to price stability and congruent prudential policies across the financial system. Progress on each of these dimensions bolsters trust in the capacity of economic policies to deliver on their mandates. Building on the resilience of the past year, the challenge for authorities is to work towards greater robustness and thus to contribute to sustainable growth going forward.
The year in review
Growth held up well in 2025, despite significant headwinds from higher tariffs and geopolitical uncertainty. Three factors stand out. First, the drag from higher trade barriers was lessened by effective tariff rates that were lower than initially anticipated, trade diversion and firms' willingness to absorb costs through lower margins. Second, a wave of optimism about AI spurred a surge in capital expenditure on AI infrastructure, lifting investment in the United States with spillovers along global supply chains. Third, animal spirits about AI lifted stock valuations, sustaining favourable global financial conditions.
Yet this resilience was soon tested in early 2026, when the closure of the Strait of Hormuz delivered a major shock to global energy supplies. Rising energy prices once again pushed inflation well above central banks' targets, echoing the post-Covid-19 inflation surge. Although the recent conflict in the Middle East seems to have abated, the economic effects of the Hormuz disruption may linger as the full restoration of physical energy supply takes time and the initial price increases propagate through supply chains. The closure of the Strait of Hormuz has raised the costs of manufacturing and agriculture inputs, with potentially dire consequences for food prices and food security among the poorest countries. Despite these challenges, financial markets have remained buoyant, reflecting expectations that the disruptions would be short-lived and the AI boom would continue.
Looking forward, four pressure points demand attention.
First, inflation has risen. The energy supply shock has been substantial, and its effects may propagate through supply chains. Global headline inflation picked up shortly after the conflict in the Middle East began, and prices of plastics and fertilisers – key inputs – have risen by 30% and 50%, respectively. The central question is whether these initial price increases will broaden and persist, as during 2021–23. On the one hand, mitigating factors limit second-round effects. Greater slack in the labour market may help to contain wage pressures. And policy rates are higher now than in 2022. On the other hand, memories of the post-pandemic inflation surge are still fresh. Given that it will take several quarters to purge the imbalances in oil physical markets, further volatility in energy prices could arise. In turn, inflation expectations could de-anchor more quickly than in the past.
Second, the optimism surrounding AI may not last, despite its promise of future productivity gains. The current surge in capital expenditure could prove unsustainable if supply bottlenecks restrain production. Intense competition for market leadership may fuel overinvestment further, as seen in previous innovation waves, increasing the risk of a sharp reversal if AI payoffs disappoint.
Third, financial vulnerabilities persist. Easy financial conditions could tighten and become a potent amplifier in adverse scenarios where interest rates rise and AI payoffs disappoint. Compressed risk premia and stretched valuations highlight the scope for unwinding. Increasingly opaque financing of AI activities, high leverage in core markets and the growing footprint of private credit further undermine the resilience of financial markets. The current tension between exuberant risk appetite and elevated macroeconomic risks could unwind abruptly.
Fourth, fiscal pressures are mounting. With already high debt levels, governments face rising demands for spending amid energy shocks and geopolitical tensions. These rising pressures coincide with a less benign financial environment than the one prevailing in the aftermath of the Great Financial Crisis. Moreover, GDP growth has also slowed from post-pandemic peaks. Consequently, interest payments as a share of GDP have risen across many countries. Compounding these fiscal challenges, the financial structure of sovereign bond markets has become more fragile, as explored in detail in Chapter II.
Old and new fiscal-financial stability nexus
In recent decades, fiscal policy has expanded aggressively during downturns but has often failed to adjust sufficiently during recoveries, especially in the face of rising public debt. Fiscal challenges are now compounded by mounting pressures from population ageing, defence spending and climate change. The resulting ratcheting up of public debt, coupled with structural changes in sovereign debt markets, poses a growing risk to financial stability in many economies.
While the traditional bank-sovereign nexus remains important, new vulnerabilities have emerged, due in part to the increasing role played by hedge funds in intermediating government debt in several core bond markets. These hedge funds employ highly leveraged strategies that rely on short-term financing on favourable terms, creating risks of fire sales and deleveraging feedback loops in response to shocks.
This evolving landscape has given rise to a novel fiscal-financial stability nexus. Financial stresses can now propagate quickly and broadly through funding markets, across borders and between banks and non-banks. Government bond market liquidity may seem ample for extended periods but can vanish abruptly, driving up borrowing costs. As a result, fiscal space can shrink well before public debt reaches limits suggested by long-run fundamentals.
Against this backdrop, central banks confront three challenges: more frequent fiscal risk repricing, more complex monetary policy transmission and more common market dysfunction.
More frequent repricing of fiscal risk and fragile liquidity would make sovereign yields more volatile. Such repricing can tighten financial conditions quickly and weigh on demand. The effects on inflation are more uncertain. While weaker demand is disinflationary, a reassessment of fiscal risk may become inflationary if it triggers exchange rate depreciation or disrupts inflation expectations.
Higher public debt also interferes with monetary policy transmission, making it more complex. When public debt is high, rate hikes raise government interest payments and transfer income to bondholders. At the same time, they reduce the net worth of financial intermediaries that hold long-term bonds, potentially curbing their lending capacity. The net effects on aggregate demand and inflation will be hard to assess.
Finally, market dysfunction may become more common, prompting central banks to intervene. But repeated interventions (and expectations of them), through large-scale asset purchases or lending operations, risk creating moral hazard for both financial markets and sovereigns. They can encourage excessive risk-taking by financial intermediaries and undermine fiscal discipline. And, in an inflationary environment, such interventions could complicate the task of stabilising inflation.
Policy implications
Central banks have demonstrated notable resolve in recent years, decisively addressing challenges such as the post-pandemic inflation surge and episodes of financial stress. However, significant challenges remain.
In the near term, monetary policy must be vigilant to anchor inflation expectations. This is crucial in a world with more frequent supply shocks. Policymakers must also assess AI's impacts on growth, financial stability and inflation. Monetary policy strategies should be robust across a wide range of scenarios.
Challenges could also arise from increasingly interwoven fiscal and monetary policies in a context of high public debt. Persistent adverse supply shocks not only complicate the task for central banks, they also intensify pressures on public spending. In this environment, prioritising medium-term price stability remains key, even where policy actions may have near-term adverse fiscal implications. A firm commitment to price stability, underpinned by central bank independence, helps to anchor long-term interest rates and expand fiscal space.
Success in maintaining price and financial stability also hinges on sound fiscal and regulatory foundations. On the fiscal side, putting public finances on a sustainable path is crucial. In the near term, this implies that measures in response to current energy supply shocks, where necessary, should be temporary, targeted and tailored. Over time, it requires restoring symmetry to fiscal policy, with consolidation during good times anchored by credible medium-term frameworks. The composition of consolidation matters as much as its pace, and spending should prioritise areas that boost growth, expand the tax base and attract private capital. Structural reforms should accompany these efforts to enhance productivity, including in transforming AI's promises into durable and widely shared gains.
Turning to financial stability policies, "congruent regulation" is essential to address new risks from non-bank financial institutions (NBFIs). Safeguards must counter excessive leverage, liquidity mismatches and vulnerabilities in sovereign debt markets. Regulatory frameworks must adapt to AI-driven risks, including cyber threats, to enhance financial system resilience. Central bank liquidity backstops remain critical tools, but they must be temporary, targeted and reversible. Expanding access to NBFIs could enhance market stability but requires robust regulation to mitigate risks.
By delivering on their mandates, policies reinforce each other. Disciplined fiscal policy underpins monetary credibility and financial stability. Robust regulation strengthens market resilience, preserves fiscal space and limits the need for frequent central bank interventions. Credible monetary policy anchors inflation expectations and helps to contain sovereign and exchange rate risk premia, thus strengthening both fiscal sustainability and financial stability.
Stablecoins and beyond
Trust is the foundation of money. What matters most is that money is accepted for payment with no questions asked. By combining central bank money – the ultimate safe settlement asset – with private sector intermediation, the two-tier system has delivered that trust. It ensures that all forms of money are redeemable at par, liquidity is supplied elastically, and integrity is upheld in everyday use. As discussed in Chapter III, these properties remain the benchmark for judging new technologies and instruments that aspire to be money.
The current system is robust. But it struggles with fragmentation across legacy systems, increasing costs, rising operational risks and limited competition. Innovative proposals include rebuilding the underlying infrastructure using new technologies, such as distributed ledger technology and tokenisation. In this context, stablecoins have emerged as money-like instruments on public permissionless blockchains.
Today's stablecoin arrangements face a number of shortcomings. They aim to maintain a stable value relative to an asset (typically the US dollar), but their value fluctuates in practice. Moreover, the current infrastructure of public permissionless blockchains exhibits fragmentation and cannot be scaled up easily. In addition, the use of so-called unhosted wallets without know-your-customer checks raises fundamental financial integrity concerns.
If stablecoins were widely adopted, a range of macro-financial implications could follow. Credit provision, financial stability, monetary policy transmission and fiscal space could all be affected. For instance, greater household demand for stablecoins could make banks' funding more expensive and less stable. This could dampen credit supply and increase risks to financial stability. At the same time, greater demand for sovereign bonds from stablecoin issuers could reduce government interest expenses and create fiscal space in issuing jurisdictions. The nature and size of these effects are highly uncertain and would depend on the extent of stablecoin adoption, their design and regulation.
In economies with relatively weak macro-financial fundamentals, high demand for foreign stablecoins could foster dollarisation, potentially undermining monetary sovereignty. Macro-financial stability frameworks conducive to ensuring fiscal, price and financial stability will be an important line of defence against such dollarisation risks.
Digital innovation is opening new frontiers for the monetary system, but the guiding principle remains trust in money. This requires progress on two fronts.
First, authorities need to address shortcomings in current stablecoin arrangements in a coordinated manner. They need to mitigate run risk and strengthen financial integrity. Whether stablecoins are to be used as money-like or investment-like assets will influence the appropriate design of regulatory measures. Given the global footprint of digital finance, deeper cooperation among authorities will be needed to support consistent, interoperable outcomes and reduce regulatory arbitrage.
Second, technological innovation should be leveraged to upgrade today's two-tier system. Tokenisation can build on an architecture anchored by central bank reserves, improving functionality through programmable platforms. Project Agorá, a collaboration among eight central banks, the BIS and over 40 private sector institutions, demonstrates how integrating commercial bank deposits and central bank reserves on a programmable platform can enhance cross-border payments.