Sunday, October 4, 2009



  • Tools for an exit strategy
  • The credibility to do it
  • Saying and doing

Since the financial crisis broke in the summer of 2007, central banks have been extremely active. On the liquidity front, all the central banks without exception acted as lenders of last resort with operations that were exceptional in terms of their size, their maturity, and the range of assets accepted as collateral. This was combined with aggressive rate cuts, starting with preemptive cuts by the Fed in late 2007, followed by the other central banks from October 2008, in response to the sharp, sudden deterioration in the economic situation.1 This phase of post-Lehman-bankruptcy financial distress plunged the economy and finance into an adverse feedback loop in which the traditional mechanisms for monetary policy transmission became ineffective, forcing the central banks to greater innovation in order to continue to act on economic activity and credit. They adopted less-orthodox methods frequently referred to as Quantitative Easing (QE), with the deployment of unprecedented measures involving active management of the size and composition of their balance sheet.

As the economic and financial environment stabilizes, thought turns to unwinding the web of unconventional measures and a return to more conventional forms of intervention. In our opinion, the central banks have numerous tools at their disposal for withdrawing, at the appropriate time, the monetary stimulus they injected into the economy. The process will take many forms, with differences across countries. The key difficulty in these exit strategies will be determining when to begin tightening monetary and financial conditions, and at what pace. This issue of Eclairages is reviewing the three dimensions of the debate: when, how, and how fast (see article “Tools for an exit strategy“, page 2). There are many possibles, as will be seen, but the central banks can depend on two assets for accomplishing this difficult task. They have very high credibility (see article “The credibility to do it“, page 6), supported by effective communication policy (article “Saying and doing“, page 10). They will be able to say what they do, be believed in what they say, and finally do what they say, with maximum efficiency.

Tools for an exit strategy
D iscussions about an exit strategy from unconventional monetary policy began shortly after the initial measures to counter the crisis, in late 2007-early 2008. The debate was sparked by the unprecedented, aggressive approaches put in place. The question was initially "how," but more recently, with signs of an improvement in the real and financial spheres, the question "when" has been added. Today, the issue thus encompasses both dimensions ("how" and "when"), and everything that will reverse current ultra-accommodative monetary policy. In other words, the exit strategy is not just a matter of what central banks do to reduce the size of their balance sheet, nor the date of the first rate hikes; they will use both of these approaches to tighten monetary and financial conditions when it becomes necessary. The reversal will also be a multifaceted process, just as the easing was, and it will unfold differently, depending on prospects for growth, inflation, and the financial system in each country.
  • How to exit
  • Why to exit
  • When to exit from current policies
To see full report: EXIT STRATEGIES