Exit from Crisis Interventions

By José Viñals

Governments and central banks rose to the challenge as the 2008–09 financial crisis unfolded, taking unprecedented steps to avoid the collapse of the global financial system and avert a devastating impact on the global economy. Liquidity support, capital infusions, and public guarantees were provided to banks and other financial institutions; policy interest rates were lowered substantially; and fiscal stimulus packages were introduced.

On top of this, international institutions like the IMF enhanced their lending facilities to help emerging markets and developing economies better cope with the threats posed by the crisis.

There are now signs of recovery in a number of the major advanced economies most affected by the crisis (photo: John Sommers/Reuters)

The good news is that these measures were broadly successful: the threat of a 1930s-style Depression was averted. There are now signs of recovery in a number of the major advanced economies most affected by the crisis, while emerging market economies are growing more strongly.

That said, the financial system and the economic recovery are still fragile. Most policymakers are taking pains to avoid withdrawing support too early, a mistake that is widely seen as having prolonged the downturn in the 1930s. Nonetheless, it is not too early to begin planning for an eventual exit from extraordinary interventions. A carefully thought out and collaborative approach will be extremely important.

The ultimate goal of the “exit” process would be to converge to a situation of price stability, sustainable public finances, and the restoration of market discipline in a safer financial sector. This will provide the necessary conditions for stable, strong, and sustained economic growth. In practice, this means several things: removing the degree of monetary accommodation introduced through low interest rates and the credit and quantitative easing policies of central banks; pursuing a vigorous policy of fiscal consolidation to bring public debt back to reasonable levels; and withdrawing the measures now in place to support the financial sector, while introducing the necessary reforms to make it safer.

In this policy response, two things are particularly challenging: reducing public deficits and debt levels sufficiently; and achieving a consistent exit process across countries.

Weak public finances

The weakened state of public finances in the big advanced economies—the United States, Japan, much of Europe—will require vigorous policy action. Population aging meant that the  fiscal situation in these countries was already extremely challenging before the crisis, and higher fiscal deficits in response to the crisis have added to the problem. Even though it is too early to withdraw fiscal stimulus, countries must develop and communicate a clear plan for reining in public deficits and public debt, to be implemented as soon as the economy is on a sufficiently sound footing.

A consistent international approach to exit will be essential to contain the risk of destabilizing spillover effects. Especially among those economies whose financial markets are closely linked, withdrawing financial guarantees or tightening regulation in an uncoordinated way could trigger sharp movements in international financial flows that could disrupt the recovery and undermine credibility.

 The IMF is actively involved in helping prepare the groundwork for a sound exit. In early November, we proposed to the G-20 high-level principles to help guide policies during the exit process.

We are also convening a conference of senior officials and financial market participants in Washington on December 3 to discuss key issues in unwinding crisis interventions in the financial sector. And, as requested by our membership, we are taking steps to ensure that policymakers across the world are fully informed about what is planned or occurring elsewhere, and are provided with up-to-date analysis on the possible policy spillovers.

One Response

  1. Scott Sumner has argued consistently and persuasively that central banks have NOT risen to the challenge, while Krugman, DeLong, and others have argued that neither have governments. While unemployment worldwide is still at very high levels and showing no signs of proper movement in the right direction, it is still to early to be trumpeting exit strategies. Monetary policy has not fired off its fullest arrows as inflation expectations are still very low in multiple countries where much more could be done to provide stimulus without risking massive inflation later on. In fact, economic theory tells us it is the very talk of these actions being temporary that makes them impotent: hoard the money now because they’ll take it back in two years.

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