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16 September 2009

ECB Smaghi: this is not – yet – the time to implement exit strategies


He remarked that it is critical to have a well thought-out exit strategy; markets have to realise that the current policy is temporary but at the same time it is important to have have a well thought-out exit strategy.

He focused on the exit strategies and highlighted that “this is not – yet – the time to implement the exit strategy. But it’s critical to have a well thought-out exit strategy, because markets have to realise that the current policy is temporary and will be reversed when it is no longer appropriate, in particular when risks to price stability re-emerge and conditions in financial markets have improved.”

He addressed the question of when to implement the exit strategy, saying that it will depend on the following issues:
·         reversibility. Once the decision has been taken, we can’t easily go back on it. This seems pretty obvious, but it has some deeper implications. If the decision to exit is taken too late and monetary expansion continues for too long, fresh seeds of instability in the financial sector will be sewn. On the other hand, if the decision is taken too early, the economic recovery might be undermined. Mistakes in the timing, both premature and tardy, (what he would call type I and type II errors), have been made in the past.
·         the uncertainties surrounding the analytical framework that central banks have at their disposal in order to decide on the optimal interest rate path. Ideally, the stance of monetary policy should be calibrated in such a way as to avoid an implicit easing of monetary conditions as the economy recovers.
·         the exit strategy from fiscal policy. There is a link with the exit from monetary policy and it will have to be considered. In particular, the more delayed the fiscal exit, ceteris paribus, the more the monetary policy exit might have to be brought forward.
 
·         the financial stability. The exit strategy for the interest rate policy will be defined on the basis of the primary objective: price stability. In this respect, financial stability can only be a secondary objective. If it were given the same priority as price stability, the latter would obviously be compromised.
 
 


© ECB - European Central Bank


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