How quickly should policy-makers reverse their policies?
On the one hand, withdrawing liquidity in such large quantities will trigger a substantial contractionary monetary policy shock.
The large size of many easing programmes will make it difficult to sell assets without a significant market impact.
If it happens too quickly or abruptly, policy-makers risk choking off the economic recovery or imposing heavy capital losses on lenders.
- For instance, in the corporate bond or commercial paper market, even small sales of securities by the central bank could cause spreads to widen considerably and to sharply tighten credit conditions for firms.
On the other hand, with policy rates at record low levels and additional liquidity-providing measures adopted in so many countries, the possibility of inflation risks emerging sometime later is not something that can be excluded.
- Retaining such exceptional policy measures for too long might aggravate the upside risks to price stability and sow the seeds for future imbalances in financial markets.
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