Policymakers in countries using unconventional monetary policy can counter volatile financial markets with clear communications about their exit plans, according to the IMF in its latest policy paper, 'Global Impact and Challenges of Unconventional Monetary Policies'.
Central banks have the tools to limit volatility from an exit from the unconventional monetary policies that helped the global economy begin to recover after the financial crisis in 2008. But some market reactions remain beyond the control of central banks, and the exit could still be bumpy at times.
“Exit from unconventional monetary policy will lead to some normal market adjustments, but there could be additional volatility due to market reactions beyond the control of the central bank", said Karl Habermeier, an Assistant Director in the IMF’s Monetary and Capital Markets Department. “This volatility could have significant spillovers to the rest of the world, with risks to macro-economic and financial stability. Countries with stronger macro-economic and policy fundamentals should cope better with market turbulences.”
Previous IMF work focused on the economic and financial stability effects in the countries using unconventional monetary policies.
Economic data and developments should be the factors that determine when and how to start phasing out unconventional monetary policies, according to the IMF. Exit could be bumpy, with increased volatility in long-term interest rates. Potential reasons for this volatility are:
uncertainty about the future path of policy rates;
uncertainty about the ability of central banks to perfectly control short-term market rates during exit in an environment of substantial excess liquidity; and
uncertainty about the effects of asset sales on prices.
The primary tool to contain potential instability is clear communication. Forward guidance is one component of a communication strategy. The Federal Reserve and the Bank of England have recently defined the economic thresholds, such as the rate of unemployment, which will determine a change in their monetary policy. This has prepared financial markets for incremental adjustments as the economy grows. There is the possibility that policymakers will have to reconsider these thresholds depending on the pace of economic recovery.
Actions to promote an orderly exit should help counter global disruptions in financial markets, although there could still be significant effects on the rest of the world. Even if the exit from unconventional monetary policies is well managed, countries can expect some reversal of capital flows, weaker currencies, higher borrowing costs, and further volatility.
Full policy paper
© International Monetary Fund
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