Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey: Navigating Exit From Extraordinary Public Anti-Recession Policies
December 10, 2009
- Conference explores unwinding monetary, fiscal interventions in financial sector
- Disagreements about risks of exiting too early or too late
- Strategies must be consistent, properly communicated
As the global economic crisis subsides and economic recovery begins, authorities around the world are beginning to consider how to navigate the complex issues involved in unwinding the large monetary policy, fiscal policy, and financial sector interventions used to support their financial systems.
Conference participants agreed on regulation’s role in ensuring that exit leads into new financial landscape that is safer than before (photo: Newscom)
EXIT STRATEGIES CONFERENCE
To that end, the IMF hosted a high-level conference on December 3 to examine the process of reversing those massive interventions by governments and central banks to stave off financial system collapse—which included capital injections into financial institutions, purchase of impaired assets, accommodative monetary policies, fiscal expansions, guarantees of debt issued by financial institutions, and expanded deposit guarantees.
The global crisis, the world’s worst economic downturn since the Great Depression of the 1930s, had its roots in the financial system in the United States and Europe, where banks and other financial institutions took on excessive risks, requiring governments to take extraordinary measures to absorb losses at financial institutions to keep the system from collapsing. The financial crisis subsequently spread globally to the real economy.
IMF to examine exit strategies
The conference at IMF headquarters in Washington, which included participants from both the public and private sectors and some Washington-based think tanks, was held the same day that the Fund announced that while supporting a firm recovery remains Job No. 1, the multilateral financial institution has begun a “thorough examination of exit strategies, including the unwinding of accommodative fiscal, monetary, and financial sector policies.”
IMF First Deputy Managing Director John Lipsky, in welcoming participants, described the conference as a forum to discuss some of the key issues involved in the gradual removal of those interventions.
Jose Viñals, Director of the IMF’s Monetary and Capital Markets Department, in an address summing up the conference, said most participants agreed that governments must have a strategy for exiting that is comprehensive and “takes into account the multidimensional nature of the problem.”
No false exits
Moreover, Viñals said, there was general agreement that the exit must be into an environment of sustained, stable, strong and balanced growth, which in turn meets a number of preconditions such as maintenance of price stability, viability of public finance, financial stability, and a competitive environment. But, he said, there was a general consensus that governments should not make a “false exit, in the sense of going to a situation which has many of the problems that we had in the precrisis situation.”
Exit decisions are complex and will differ across countries. Against this background, Viñals acknowledged differences of opinion on the timing of the exits. There were those who thought the risks of exiting too early are most important because of the possibility of damaging the still fragile recovery.
Others, though, believed that “the bigger risks were of exiting too late” because of political pressures and because there could be an “underestimation of the long lags with which monetary policy” affects the economy. Exiting too late from accommodative policies could lead to asset price bubbles down the road and possibly more immediate inflation pressures.
Viñals said the IMF viewpoint is clear: “The risks of exiting too early are larger at this time than exiting too late.”
Providing solid economic indicators
To be able to make informed judgments on the “appropriate pace of fiscal consolidation and of the withdrawal of monetary stimulus,” as Lipsky put it in closing remarks to the daylong conference, policymakers must look at a variety of economic and financial indicators such as corporate spreads and credit to the private sector. Lipsky said the conference produced many interesting suggestions on those indicators and promised to share information about refining and monitoring these indicators and about “the scope for sharing high frequency information on the aggregate fiscal and monetary stance.”
Lipsky also noted the debate about sequencing the exit—whether withdrawal of fiscal (taxing and spending) stimulus should precede monetary tightening. The benefit of drawing down fiscal stimulus first is speed, with the return realized through both lower deficits and lower interest payments. The potential counter-argument, he said, is “the risk of encouraging an outsized risk of excessive asset price increases.”
Need for consistency
Viñals, in his summing up of the proceedings, pointed to the participants’ recognition of the importance of regulation, so that the exit is into “a new financial landscape that is safer than the one we had before.” Moreover, he said, any unwinding decisions need to be consistent. Domestically, exit strategies must be designed in a way that makes sense in terms of a country’s overall financial and macroeconomic stability objectives.
In addition, he said, exit strategies must take into account their international implications. At a minimum because of potential spillover effects, the unwinding should be guided by “common principles” and should be transparent, clear, credible, and flexible. In cases in which countries have “very close financial relationships” and the effect of policy changes in one can be immediately felt in another—such as the removal of bank deposit guarantees—there should be “some explicit coordinating mechanism.”
Selling assets
There was much discussion of how to deal with the assets on the books of central banks and governments—especially those acquired through operations to absorb losses on the books of financial institutions. The question is how to sell them and when to sell them. Viñals said that those assets should be disposed of as “part of asset sales programs that are clearly understood by markets.” Whether the risky assets should first be transferred from the books of the central banks to government treasuries was also a matter of some debate.
Most participants agreed that the most costly and distortionary measures should be removed first, while measures that involved “the restructuring of financial institutions or the nationalization of banks should be those that take a longer time to unwind.”
For those institutions that have been propped up substantially, their return to private control should be done carefully and in a way that “does not create a situation that could undermine financial stability.” Authorities should demand that these institutions produce business models that demonstrate they can “avoid the same problems in the future as the ones we had in the past,” Viñals said.