Working Paper: Exit strategies

The extremely expansionary monetary and fiscal policy was essential in the wake of the severe financial market and economic crisis and its consequences are still difficult to gauge. “But it is clear that risks and costs will rise the longer the expansionary policy remains in place. It is therefore time to work out alternative exit strategies,” said Michael Heise, chief economist at Allianz. According to Allianz, an optimal exit concept should be timed correctly, avoid new financial market bubbles and be coordinated internationally.

The timing of the exit is crucial as, on the one side, the economic recovery must not be jeopardized while, on the other, inflationary risks must be avoided. According to Allianz, the world economy is enjoying a marked rebound which is set to continue in 2010 as well, allowing economic policy to temper its expansionary stance. However, the recovery is not yet self-sustaining. The envisaged global fiscal boost for 2010 contained in the various stimulus packages should therefore be implemented as planned. But, beginning in 2011, active consolidation should then be tackled.

An exit from monetary policy should begin earlier than for fiscal policies. “Monetary policy measures take longer to feed through and would have scant impact on the economy in 2010. The aim now must be to rein in the expansionary degree of monetary policy somewhat in order to counter excesses on the financial markets,” said Heise. The exit from expansionary monetary policy should be coordinated at the international level. The only way to avoid major ructions in the exchange rate framework is for central banks in the US, Europe and Asia to move in the same direction.

In Europe the only sensible approach to a fiscal policy consolidation strategy from 2011 is on the expenditure side. The government spending ratio in the euro area is set to rise by around 4 percentage points to over 50 percent by 2010, an extremely high figure. Starting in 2011 government expenditure should be held 2 percentage points below nominal GDP growth. In this scenario the government spending ratio would fall back to around its pre-crisis level by 2014 and annual borrowing could drop from 5.7 percent of GDP in 2010 to1.8 percent in 2014.

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