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Finding the Policy Exit

NEW YORK – There is a general consensus that the massive monetary easing, fiscal stimulus, and support of the financial system undertaken by governments and central banks around the world prevented the deep recession of 2008-2009 from devolving into Great Depression II. Policymakers were able to avoid a depression because they had learned from the policy mistakes made during the Great Depression of the 1930’s and Japan’s near depression of the 1990’s.

As a result, policy debates have shifted to arguments about what the recovery will look like: V-shaped (rapid return to potential growth), U-shaped (slow and anemic growth), or even W-shaped (a double-dip). During the global economic free fall between the fall of 2008 and the spring of 2009, an L-shaped economic and financial Armageddon was still firmly in the mix of plausible scenarios.

The crucial policy issue ahead, however, is how to time and sequence the exit strategy from this massive monetary and fiscal easing. Clearly, the current fiscal path being pursued in most advanced economies – the reliance of the United States, the euro zone, the United Kingdom, Japan, and others on very large budget deficits and rapid accumulation of public debt – is unsustainable.

These large fiscal deficits have been partly monetized by central banks, which in many countries have pushed their interest rates down to 0% (in the case of Sweden to even below zero), and sharply increased the monetary base through unconventional quantitative and credit easing. In the US, for example, the monetary base more than doubled in a year.