Christine Lagarde on the coming post-QE world

August 23, 2013

Q-Wheee or Ew-eee? Either way, the end of the road for unconventional monetary policy may be near. (Andrew Harrer/Bloomberg)

JACKSON HOLE, Wyo. – The world’s central banks have spent the past several years propping up the global economy and rescuing the world from crisis. Now, argues the head of the International Monetary Fund, it is time to grapple with the consequences.

The Federal Reserve, European Central Bank, Bank of Japan and other central banks have used a range of tools to try to spur growth and fight crises in their nations; the Fed, for example, is on track to soon own around $4 trillion in assets, up from $800 billion it held before the crisis.

Christine Lagarde, the managing director of the IMF, has been broadly supportive of these efforts, and stresses that they should only be unwound as economic conditions improve. But in a speech to leading central bankers and economists Friday at the annual economic symposium organized by the Kansas City Fed, she urged more reckoning with some of the less pleasant side effects for global finance, particularly the risk of bubbles and instability.

It is important, Lagarde said, “to communicate the risks on both sides of the equation—the risks to recovery from exiting too soon and the risks to financial stability from exiting too late.”

In just the past couple of months, there have been signs that the unwinding of the extraordinary interventions will be a bumpy ride. In the United States, interest rates have spiked dramatically since June as the Fed has signaled it will soon slow the pace of its policies of buying bonds. That prospect has also sparked a selloff in the Indian currency, the rupee, and many other emerging nations’ bonds.

The gush of money injected into the global financial system may well be a cause of the instability, with the big swings in currency and bond markets a reflection of “hot money” sloshing around the globe.

Lagarde floated the idea that nations may need to intervene in foreign exchange markets to help moderate this volatility, that restrictions on the flow of capital can be useful “in some circumstances.” It is the latest example of the IMF, long an advocate of the free global flow of capital and flexible exchange rates, taking a more open-minded view toward policies aimed at reducing the hot-and-cold nature of modern financial markets.

Indeed, Lagarde added that the IMF stands ready to help if the unwinding of extraordinary monetary policy creates severe ripple effects around the globe.

“For the Fund’s part, we stand ready to provide policy advice and financial support, including on a precautionary basis through our various instruments,” she said.

The concern over the side effects of half a decade of activist monetary policy was a recurring theme at this year’s Jackson Hole conference, which did not feature the usual opening-session speech by Fed Chair Ben Bernanke, who did not attend.

“At the end of the day we cannot live forever on unconventional monetary policy,” said Augustin Carstens, the governor of the Mexico’s central bank. “”It would be desirable for advanced economies to implement a more predictable exit.”

Indeed, Lagarde expressed a fear that the interventions of central banks have given other policymakers the time to make deeper reforms in how their economies work—but that those offiicals haven’t done enough to use the time.

“I do worry that all the hard work of central banks will be wasted if not enough is done on other fronts—to adopt the admittedly more difficult policies needed for balanced, durable, and inclusive growth. . . . [unconventional monetary policy] is providing the space for more reforms. We should use that space wisely.”

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Brad Plumer · August 23, 2013