The Group of 20 finance ministers and central bank governors agreed at a meeting in London on September 5 that it was far too early to begin unwinding the emergency measures taken to rescue the global economy. “We will continue to implement decisively our necessary financial support measures and expansionary monetary and fiscal policies, consistent with price stability and long-term fiscal sustainability, until recovery is secured,” they said in the communiqué.
It became clear less than a week later, however, that countries around the world already were quietly unwinding their extraordinary stimulus programs. US Treasury secretary Tim Geithner announced that the government was trimming back its support for banks and financial markets because they no longer needed the help. The Federal Reserve also has sharply cut its emergency loan programs. The Fed, which seeks the dual objectives of maximum employment and price stability, says it will not tighten its monetary policy for an extended period. The European Central Bank, whose sole mandate is to ensure price stability, says it could raise interest rates before withdrawing the extra liquidity, if that is what the markets require.
Once interest rates start going up, they may rise just as quickly as they fell during the crisis. Of course, this has implications for foreign exchange and other markets. “We will develop cooperative and coordinated exit strategies, recognizing that the scale, timing and sequencing of actions will vary across countries and across the types of policy measures,” the G-20 finance leaders said in London.
Governments are turning their attention from fighting recession to making sure that the recovery is sustainable. The costly stimulus programs obviously could not go on forever without creating an inflation problem. Concerns about fiscal deficits and prospects of inflation could choke off the recovery before it gets going, economists warn. The policy transition will be tricky and fraught with risk. Any coordination that can be achieved on the interest rate front when the time comes to tighten could limit the potential disruption to financial markets.