Monetary policy exit scenarios in the euro area and in the US

In order to combat the financial and euro debt crisis and achieve the degree of monetary expansion that is deemed appropriate, major central banks have not only nudged their key rates down to record lows touching on zero, but have also been experimenting with a number of new instruments. The Fed has turned to unconventional measures in the form of extensive asset purchases and forward guidance to push long-term interest rates down. The ECB has opened its liquidity floodgates with unlimited allocation for "normal" refinancing operations, three-year tenders and the expansion of the collateral pool, has bought a limited volume of government bonds and created a set framework for further government bond purchases.

Low money and capital market rates, combined with an abundance of liquidity in the international financial system are reinforcing the economic recovery. At the same time, however, relatively safe investments are becoming less attractive. This is a welcome development to a certain extent: investors are given an incentive to shift their funds to riskier investments that hold the promise of higher returns, which generally helps to promote more favorable financing conditions. The "hunt for returns" can, however, also bring about adverse developments: if risks are concealed or understated, they can end up being concentrated in various areas of the economy and financial system unexpectedly. The low interest rate environment may prove to be a breeding ground for future financial imbalances. When deciding whether to continue with the unusually expansive monetary policy over a more prolonged period of time, it is important to weigh up the benefits and the risks.

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