July 16, 2024

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Central banks must embrace artificial intelligence, report recommends

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Central banks should be preparing for the transformative impact artificial intelligence will have on the financial system and the economy, according to a new report issued by the Bank of International Settlements (BIS).

The BIS’s annual report urges monetary policymakers to become better adopters of the technology for their own purposes of forecasting and providing financial stability.

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“New-generation AI models have captured our collective imagination through their uncanny abilities, but they also have a direct bearing on how central banks do their jobs,” Hyun Song Shin, head of research and an economic adviser at the BIS, said. “Vast amounts of data could provide us with faster and richer information to detect patterns and latent risks in the economy and financial system. All this could help central banks predict and steer the economy better.”

One development from the increased adoption of AI would be the ability of central banks to take full advantage of what’s called nowcasting, which uses real-time data to improve the accuracy and timeliness of economic predictions.

For example, generative AI large language models (LLMs) can use information from social media posts, financial statements and earnings reports to create a sentiment index, which could then predict the possibility of economic recessions and monitor the build-up risks.

Adopting AI technology, however, faces hurdles since LLMs still struggle with logical reasoning and can provide factually inaccurate answers. But as it develops, it could be a very important analytical tool for policymakers.

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“I think it will lead to better decision-making, both in the markets and among decision-makers in monetary policy, but there is still a little bit more work to do before we get to that particular vision,” Cecilia Skingsley, head of the BIS Innovation Hub, said.

AI could also help better track data at a more granular level when it comes to the financial system, the employment market or even give better insights into supply-chain bottlenecks.

The report warns that the adoption of AI in the financial system is not without its drawbacks. Its use can make the financial system more susceptible to cyberattacks and if all financial institutions are using the same algorithms, it could lead to more market volatility by exacerbating herding, liquidity hoarding, runs and fire sales. These all pose new challenges for central banks as stewards of economic stability.

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“Central banks have a history of successful collaboration to overcome new challenges,” the report said. “The emergence of AI has hastened the need for co-operation in the field of data and data governance.”

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