CentralBanking.com panel: it’s too soon to exit

Charles Goodhart, Paul Mortimer-Lee, Lucrezia Reichlin and Gabriel Stein concur that dangers are greater from exiting too early than too late but warn that asset prices risk becoming over inflated

It is too early for central banks to begin implementing an exit strategy for the extraordinary monetary policies they have implemented as a result of the crisis, four experts said on Wednesday.

With no sign of inflation and the economic recovery still vulnerable, central banks should err on the side of caution, the panel of Central Banking ON AIR's web seminar on exit strategies agreed.

"Exiting too early is the greatest danger," said Paul Mortimer-Lee, the global head of market economics at BNP Paribas. "[On exiting too late], the real danger is not inflation, but inflation expectations. Central banks should talk tough but act weak."

It was not the time to exit now, said Lucrezia Reichlin a professor at the London Business School and a former director general of research at the European Central Bank (ECB), as there were no signs of danger of inflation. But she added: "It might be time to get out of some of the special [liquidity] measures." The ECB announced plans to withdraw some of its crisis fighting open-market operations last week and Canada has already done so.

Gabriel Stein, the chief international economist at Lombard Street Research parried concerns that the Fed would stoke inflation, saying: "The US does not have strong incentives to inflate away its debts: that would hurt loyal allies, like Taiwan and Japan, or damage the assets of baby-boomers' pension funds."

Before raising rates, central banks had to be sure the economy was on a sound footing and that there is a very firm trend in employment growth, said Mortimer-Lee. "An economic recovery will not be sustainable without a sustainable recovery in consumption and this relies on a sustainable recovery in employment. "In this vein he was most concerned about Europe, where labour markets are more rigid.

Both Mortimer-Lee and Reichlin thought there would be no rate hikes in 2010 in the euro area or the US. Reichlin argued that the Fed would be the first out of the two to hike, saying: "Europe will get out trouble when the US gets out of trouble."

Stein agreed: "You need above trend growth to reduce output gap. In the run-up to the crisis the spenders overspent, now the savers have to spend. Europe is looking to export-led growth but where will the demand for those exports come from?"

However, the experts cautioned that it was important to learn the lessons of previous cycles and avoid raising rates too late.

In terms of indicators, Stein said you would need to see broad money growth of 6-7% for a sustained period before raising rates.

Blowing bubbles
But panelists acknowledged that asset prices could already be too high. Mortimer-Lee said: "There is some danger that we have asset price bubbles. But the dangers of bubbles are much worse in emerging markets where policies of dirty floats mean countries are importing US monetary policy, which is right for US but not right for them."

However, Stein warned it was not just an emerging market issue. "In Sweden the housing market is picking up. I know the Riksbank is worried but can't do anything about it."

Lessons from Japan
For Charles Goodhart, a member of the Financial Markets Group at the London School of Economics, the main lesson from the Japanese experience was that the central bank was far too conservative and "tiptoed into doing the least they could." The Bank of Japan had, he said, "consistently been on the wrong side of the argument."

Mortimer-Lee noted Fed chairman Ben Bernanke's comments that in Japan there was not the social and economic consensus to get out of deflation: "With low interest rates you can borrow cheaply long term and push your fiscal problem into the future. This is what happens if you don't act quickly enough."

He added: "Who is most in danger of being like Japan? Europe. The fear is that Europe act too slowly."


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