Although there is plenty of chatter among central bankers and other experts on the need to withdraw the emergency monetary and fiscal measures, not all central bankers appear to be in favour of such a move in the immediate future.
With growth impulses not yet credible, many of them would like to wait until confidence in the growth sustainability returns.
They are also under pressure from the beneficiaries of emergency measures to continue with such measures for some more time.
Recent days have seen a clear division of opinion. US Federal Reserve Chairman Ben Bernanke’s position is that emergency measures may have to continue for a few more quarters, particularly because unemployment at around 10 per cent is still very high.
The European Central Bank, on the contrary, is coming closer to a view that it is time to act. The recent speeches of its office-bearers, including President Jean-Claude Trichet, give strong signals the bank was more worried about the deterioration in the fiscal picture and possible inflationary impact of the easy money policies than about other parameters. It is also worried about markets becoming over-dependent on monetary and fiscal supports.
The International Monetary Fund is consistent in its stand that the time for policy reversal is yet to come. Its Managing Director Dominique Strauss-Kahn said on Monday, “Exit too soon, and you kill the recovery. Exit too late, and you sow the seeds for the next crisis. We recommend erring on the side of caution, as exiting too early is costlier than exiting too late.”
Among the sharp division, Indian authorities are tilting towards a play-safe approach. Not long ago, Reserve Bank of India Governor D Subbarao had put a cat among pigeons, when he indicated in one of his speeches that policy tightening might be round the corner.
Although he did announce some reversals later, they were mostly peripheral, and did not impact the markets.
On Tuesday, the newly appointed deputy governor of RBI, Subir Gokarn told the media that exit from the accommodative policies would be on the central bank’s agenda over the next few months.
Beyond the debate, what will decide the matter is the confidence that the economy is capable of growing without the accommodative policies. That, unfortunately, is the biggest uncertainty.
While the experience of the Great Depression enabled central banks to initiate measures to tackle the current crisis, getting out of them is a new, untested paradigm, where they are on a learning curve.
It is therefore not surprising that the lack of experience makes the progress towards policy reversal slow and hesitant, like trying to find a way in the dark.
Global linkages
Since different countries are at different levels in the growth process, it is to be expected that some of them will start reversing their policies before others. For example, Asian economies would be expected to start the process before the US and Europe.
However, there are international linkages that too would have to be taken into account here.
Given the global trade and capital flow linkages that have strengthened in the last two decades, no country would be at liberty to look just at its own economy while taking a decision on this issue. It will also have to look beyond its borders.
In a recent speech, Lorenzo Bini Smaghi, member of the executive board of ECB, has pointed out that different countries were at different levels of preparedness for exit strategies. But no country seemed keen to take the step.
And this has a distortionary impact.
“The delayed exit in emerging Asia is affecting other countries. In particular, the interventions in the foreign exchange markets to prevent emerging Asian currencies from appreciating are shifting capital flows towards other regions, such as Latin America, and pushing up the exchange rates of currencies there, in a disproportionate manner. This may in turn cause Latin American countries to adopt measures to counter capital inflows and also to intervene in the foreign exchange markets and accumulate reserves, thereby further delaying the exit,” he said.
Also, preventing the emerging Asian and Latin American currencies from appreciating, in parallel with the recovery, reduces the export competitiveness of those countries which are recovering more slowly, like the US, and thus further delays their exit, he added.
Besides trade distortions, the reinvestment of foreign exchange reserves accumulated in emerging Asia contributes to flush the US financial markets with liquidity, making the exit more complicated.
Without a credible commitment to a timely exit from the expansionary monetary and fiscal policy in advanced economies, in particular the US, aimed at reducing the net supply of government bonds, emerging Asian and Latin American economies might be reluctant to exit in a timely way, as they would suffer a significant loss in the value of their stocks of foreign reserves.
“To sum up the argument, emerging economies may have an incentive to exit in a timely way from their expansionary policies if they can be certain that advanced economies, starting with the US, will do the same when their domestic conditions allow it.”
This clearly calls for greater global cooperation and coordination among countries, so that any apprehension on the part of countries deciding to take the first step is removed. This does not appear to have happened yet.
“Institutional mechanism of global co-ordination is getting reactivated after the G-20. (However) There is no road map to tell us how co-ordination must be done,” said Gokarn.
