Exit strategies from unconventional monetary policy measures of selected central banks

With conditions in the financial markets and the real economy improving, central banks are considering ending the use of unconventional measures. Their plans to terminate such measures are called “exit strategies”. By defining an exit strategy, central banks will specify the steps they will take when it becomes necessary to end the monetary policy easing and when growing inflationary pressures will conversely require tighter monetary policy. In general, the exit strategy should define the sequence and timing of the steps needed to exit markets or discontinue programmes. It should also include estimates of its impacts on the markets. The decision on the timing and speed of withdrawal of unconventional measures is of particular importance. On the one hand, early withdrawal might undermine the nascent economic recovery. On the other hand, a delayed decision on this matter might endanger the medium-term equilibrium of the economy and the financial sector. When taking such steps it is equally important to respect not only monetary policy objectives and the inflation outlook, but also the need to maintain and strengthen financial stability and restore the efficient functioning of the banking sector.

As regards the sequence and combination of steps relating to the termination of the cycle of easy monetary policy, the most likely procedure seems to be one in which liquidity-supporting programmes are first discontinued and monetary policy rates are later raised, paying due regard to the inflation outlook and the state of the real economy. The selection of specific instruments and procedures to absorb the liquidity generated by purchases of financial assets remains open for the time being. A discussion is going on about whether the purchased securities will continued to be held in central banks’ balance sheets and liquidity will be absorbed, for example, by conducting reverse repos or issuing central bank bills, or whether the purchased assets will be gradually sold in the markets.

The Federal Reserve System (Fed) plans to discontinue most of its liquidity-providing programmes, lending to financial entities and swap lines on 1 February 2010. After this date, the Term Auction Facility (TAF)1 and the Term Asset-Backed Securities Loan Facility (TALF)2, will probably remain in force. Termination of the credit easing, i.e. purchases of mortgage-backed securities and agency bonds, is planned for 2010 Q1. These securities currently account for almost half of the Fed’s balance sheet, which has increased considerably in volume as a result of these purchases. To absorb liquidity from the system, the Fed is considering using reverse repos and deposits and, if necessary, selling off part of its debt securities.

The European Central Bank (ECB) has changed the method for calculating the interest rate on its one-year refinancing operation. The rate was originally set at 1%, but the rate in the December auction (the last one) is fixed to the average minimum bid rate on main refinancing operations to be conducted over one year. The rate will thus be set ex post. The ECB has also decided to carry out its last six-month refinancing operation on 31 March 2010 and to discontinue the weekly EUR/CHF swaps with the Swiss central bank on 31 January 2010. Termination of the covered bond purchase programme is planned for the end of June 2010. Roughly half of the planned volume of covered securities has been purchased to date.

The Bank of England (BoE) is continuing to apply quantitative easing through purchases of debt securities, in particular government bonds. The announced volume of asset purchases of GBP 200 billion is now almost fulfilled, so the purchases are likely to be discontinued. The BoE is proposing the following two options for its exit strategy and simultaneous monetary policy tightening when the inflation outlook exceeds the inflation target of 2%: either (i) an increase in the key interest rate combined with the simultaneous sale of purchased assets, or (ii) the issuance of central bank bills to decrease the volume of liquidity without selling financial assets in the BoE’s balance sheet. The gradual withdrawal of unconventional monetary policy measures by central banks is a positive signal, since it reflects improved conditions in the financial markets and the real economy. However, despite the relative ease of discontinuing most liquidity-providing facilities, there are still question marks hanging over the size and structure of some central banks’ balance sheets, which include significant volumes of purchased debt securities of private and public entities with long maturities and various levels of risk.

1 TAF – a facility that allows depository institutions to borrow funds against collateral, with 28-day or 84-day maturity. The declared volume of the facility is set by the Fed and the operations take place on the basis of an auction with a minimum bid rate. This facility is similar in nature to the ECB’s usual refinacing facility.

2 TALF – a facility for providing funds to support securitisation by helping interested parties to finance purchases or sales on the asset-backed securities market. Three- or five-year loans are provided against collateral composed of newly issued commercial mortgage-backed securities (to terminate on 30 June 2010) and other securities backed by a broad range of assets (to terminate on 31 March 2010).