Take the 1st EXIT in the nearest roundabout!
That is the end of quite a forgettable year, but with a better than expected ending and probably with a even better outlook for the new year. If I had to choose the ‘one’ thing to look out for in 2010, it would be the ‘Exit Strategy’. With the monetary and fiscal stimulus measures already in place for more than a year now, central banks and governments have now started contemplating about a timely exit.
Given that the recession has ended, and that inflationary pressures are showing up along with very high public debt levels (signaling even more inflationary pressures) the argument for an exit is very strong. Countries like Israel, Australia and Norway already started their hiking cycles few months back and the pressure is building amongst others and the obvious question of ‘How and When to Exit’ is going to be the most sought after topic in the coming year. Let me try tackling the above question in parts.
How?
The government can either start consolidating its finances as public deficits and debts continue to blow up or start raising the interest rates as a monetary policy stance. The current as well as projected debt levels are so high for some countries that it might look imperative for the governments to act on the fiscal policy first. And the moment political pressures get built up on the central banks to monetize this debt level, the central banks would keep on consuming (read ‘buy the debt’) thereby adding to further increase in money supply and hence huge inflationary pressures.
But fiscal policies are sometimes deemed ineffective largely stemming from its lack of flexibility. Fiscal tightening would often hit the roadblock of political compulsions and you would seldom find a government opting for one when its parliament is due for elections soon. Moreover, a change in a fiscal stance, be it curbing expenditure or say a raise in tax would always have to wait till a new budget is due to be placed. Monetary policy on the other hand is far more flexible as central banks have the option of reviewing the state of the economy every month and take a decision. Though it is not fair to believe that monetary policy would not face the similar political roadblock, but central banks in general try to be independent, pursuing their own macroeconomic policy objectives. At this juncture, it is quite reasonable to expect the central banks to act first, as the fiscal stimulus packages would in any case soon expire and is not getting renewed in most of the countries. Fiscal adjustments would happen keeping political compulsions in mind and would come at a much later stage.
When?
This is probably the tougher of the 2 questions. In order to avoid a ‘W’ shaped double-dip recession most countries would want to see the last, and allow for the accommodative monetary and fiscal policy as long as possible. However, a loose monetary stance can translate into inflationary pressures and as well as fuel more asset price bubbles. On the other hand, accommodative fiscal stance would lead to excessively high public debt levels. It is thus going to be very tricky to ‘time’ this exit. Central banks, mostly being inflation targeting, would look out for signs of recovery in the domestic as well as the international market, and eventually start hiking the benchmark rate in 2010, but reaching a political consensus prior to that is probably even more crucial.
