Central banks on both sides of the Atlantic are pondering ways of unwinding their bloated balance sheets and easing out of extraordinary post-crisis monetary policy interventions. This column discusses the recent Geneva Conference on the World Economy that focused on ‘exit strategies’. Where exactly do central banks exit? And how? This column also introduces a new Vox feature, ‘Vox Views’, which are short video interviews with world-renown economists. The first two of these feature Alan Blinder and Don Kohn.
Right now, most central banks in developed countries are deeply focused on finding ways to support a lackluster economic recovery from the 2009’s Great Recession. In some cases, these banks are struggling to exit from a double dip. With interest rates at the zero lower bound, these efforts are taking the form of a massive expansion of liquidity. Behind this unprecedented effort lies a seldom-discussed question: how do we revert to normality when it’s all over? It is certainly not yet time to act but it is never too early to think carefully about such a complex and untested process.
‘Exit strategies’, as this process is often called, were the topic of the 15th Geneva Conference on the World Economy, which took place in Geneva on 3 May 2013. The debates were structured around two main questions: Where to exit to? How to exit?
Alan Blinder introduced the first issue, his key message being that the new, ‘normal’ monetary policies would differ from the pre-crisis consensus that a central bank should pursue inflation targeting and ignore financial stability. The future relevance of inflation targeting was heavily debated, focusing partly on how it should be defined. However, there was widespread agreement on three main points:
- Financial stability is now recognised as an implicit responsibility of central banks;
- Many new instruments have been experimented with since 2008 – including central-bank purchases on long-term assets – and they will not be abandoned;
- Central banks are now involved in macroprudential financial supervision, which is not completely separate from microprudential supervision.
The expanded role of central banks – often in areas that are unavoidably political – led to many conference participants expressing their concern about central-bank independence:
Don Kohn introduced the second issue: the first question is ‘when to do it’?
- Some conference participants were of the view that it is better to act early rather than too late, avoiding the risk of rekindling inflation; Others were of the opposite view, fearing another recession;
- Do we raise interest rates or, first, re-absorb liquidity?
It may seem natural to first raise the interest rate, but who will bear the ensuing capital losses on long-term bonds: central banks that now hold substantial amounts, or the private sector?
- The third question is which assets central banks should dispose of, and in which order;
Here the discussions revealed how intriguing is the newly discovered ability of central banks to shape the yield curve. Should this ability be used as part of the exit strategy? Should it be exercised in the ‘new normal’?
A common theme running through these questions was, again, that the exit strategy was bound to be highly political. Withdrawing policy support is always delicate, but the scope for capital losses and the impact on fiscal policy of large-scale bond sales stand to make exit highly controversial.
Overall, it’s clear that central banks need to prepare the public and the politicians.
Editor’s note: This was the 15th conference organised by the International Center for Monetary and Banking Studies (ICMB). These conferences bring together academics, policymakers and financiers to discuss key policy issues. ICMB and CEPR will jointly publish in July a full Geneva Report on exit strategies.