By José Viñals
The IMF held a high-level conference last week on unwinding public interventions in the financial sector. Insightful discussions took place among policymakers, academics, and the private sector, highlighting several areas where a broad consensus appears to be emerging, as well as some challenges that policymakers are about to face.
There was broad agreement that an exit strategy from monetary, fiscal, and financial sector interventions is essential. The pivotal goal of this exit process would be to arrive at a condition of price stability, fiscal sustainability, and financial stability, including a new financial landscape that is much safer than currently exists. This will provide the necessary underpinnings for stable, strong, and balanced growth.
The strategy will need to be clear, credible, consistent, and comprehensive, addressing the multidimensional issues that have ensued from the intervention measures. That said, tailoring the strategy will likely be more an art rather than a science because of the uncertainties and the need to have firm assurances that it will not undermine recovery.
Views differed regarding the timing of the exit process. Some participants argued that it was better to exit earlier because of possible fiscal policy lags and/or potential new asset bubbles. Others argued it was too early to exit given that global economy prospects still remain highly uncertain. On balance, however, the Fund believes that the risk of exiting too early is higher than exiting too late.
There was also no clear consensus regarding the sequencing of an exit strategy.Some felt that fiscal adjustment should take place first to ensure easier exit from monetary policy measures. Others argued this may not be feasible because the political process of unwinding fiscal interventions would likely be long and complicated and hence monetary policy accommodation should be unwound first.
Some principles for exit strategy
Exit strategies need to be consistent at three levels. First, there needs to be consistency between monetary, fiscal, and financial policies in each country. Second, exit plans from different financial sector interventions need to be consistent. Third, individual country policies should be internationally consistent to avoid undesirable spillover effects, including from advanced to emerging market economies.
Further, economic and financial indicators should guide the exit strategy. These indicators should include quantity, as well as price signals—in particular, developments in the aggregate and sectoral credit variables.
Main challenges ahead
There are many challenges that lie ahead. The most difficult will be the fiscal exit because of the political nature of fiscal policy. Credible fiscal rules and institutions need to be put in place to bring debt ratios back to reasonable levels, while contingent liabilities should be better accounted for in fiscal positions to provide a more accurate picture of fiscal risks.
Although the technical ability of monetary authorities to unwind the easing is not questioned, how to do it and when to do it will be challenging tasks mainly because of uncertainties related to the correct estimation of potential output and size of output gaps in a post-crisis environment.
It will be relatively easy to unwind financial interventions that have sunset clauses or have penal rates so they become unattractive as market conditions normalize. The challenge is how to offload risky assets in central bank balance sheets and how to unwind debt guarantees and blanket deposit insurance.
Role for the IMF
The International Monetary and Financial Committee (IMFC) has asked us to continue work on these issues, and we will soon have a discussion in the Fund’s Executive Board on good principles for exit.
(for another view, See Simon Johnson’s blog on the event).