13 December 2013

Ansgar Belke: Exit strategies and their impact on the euro area – A model based view [prepared for ECON MD]

Belke discusses the issue of policy coordination between central banks in the light of the substantial potential spillover effects via capital flows and exchange rate adjustments of unconventional monetary policies. The risks of a premature versus a delayed exit are assessed.

This briefing paper was prepared for the ECON Committee's Monetary Dialogue on 16.12.13.

This Briefing paper comments on the pros and cons of exit strategies with a specific focus on the impacts of the exit from unconventional monetary policies (UMP) by the Fed, which, if at all, appears to be the first central bank to move on the euro area economy.

From a market economy perspective, it is clearly desirable to have international policy coordination in place, which ensures that non-pecuniary cross-border policy spillovers are appropriately internalised. However, induced exchange rate changes are part of the necessary portfolio adjustment to the new global equilibrium, accompanying the unilateral exit. Accordingly, they should be classified as pecuniary effects and cannot serve as a justification of coordination.

The risks of a premature or delayed exit are assessed - more specifically, the risks posed by the exit from unconventional monetary policies and a turning of the interest rate cycle both for the exiting countries and for other regions in the world due financial spillover effects. This paper starts by examining the risk associated to spillover effects and then looks at different potential shapes of exit paths. There is a lot of uncertainty around exit decisions and their impact both on policy instruments (e.g. interest rate volatility) and targets (e.g. debt sustainability), which must be taken into account by policymakers when designing an exit strategy.

Based on new and innovative global IMF models, this paper reports estimates of the impact of the Fed’s exit from UMP in 2014 on the euro area economy. To this purpose, three different possible modes of exit are distinguished:

• a "smooth growth-driven exit",
• a "growth-driven exit with complications" and
• an "exit without growth".

The exit is assumed to start via endogenous or exogenous tightening in the third quarter of 2014. However, the different scenarios allow for different ways of phasing out from the UMPs. Adequate communication seems to be an important tool to contain instability during the exiting process. However, it is likely that this normalisation will take longer than originally envisaged - there is the danger that UMP will become the "new normality".

Full paper

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