Guru Speak: Monetary-policy conundrum during global recovery

Early last month, the Reserve Bank of Australia became the first central bank in advanced economies to kick off policy interest-rate hikes. Although the slowdown in unemployment and rising inflationary pressures were the main reasons, it is suspected that rising asset prices were also an important reason behind the policy move.

 Many anticipate that the policy rates in the G-3 (US, Japan and European Union) economies will be kept on hold for a while longer. This is because the economic recovery trajectories in those economies will likely be gradual due to lingering major risks from rising employment and fragile bank balance sheets.

However, the lower potential output due to structural disruptions in G-3 from the crisis would imply that inflationary pressures may emerge - once the recovery appears more solid - more quickly than in the past.

Policy-makers have also learned a big lesson about the risk of contributing to asset bubbles from overextending the period of accommodative monetary policy.

Therefore, it is likely that authorities will start to raise policy rates as soon as growth shows signs of sustainability and inflationary pressures become more imminent.

In this regard, some economists think the Fed may begin to hike its policy rate even before there is a significant fall in the unemployment rate. This move would ease inflationary pressures from the massive liquidity injections into the US economy during the crisis.

As for emerging economies, which have experienced faster recoveries, South Korea, Singapore and Hong Kong have already witnessed escalating home prices. It is plausible to expect that some of these central banks in Asia may consider tightening monetary policy even before those in the G-3.

However, a policy dilemma in Asia comes from massive capital inflows that have led to local currency appreciation. Hiking interest rates will widen interest-rate differentials with the G-3 and fuel rising capital inflows, adding pressure on exchange rates and undermining the overall recovery.

It is therefore uncertain when monetary tightening will occur in Asia, though prudent measures to curb asset-price increases will be helpful in the meantime.

 Despite impending inflationary and asset-price pressures, policy-makers worldwide will focus on ensuring sustained growth at this stage. The recent G-20 agreement on exchanging details on individual exit strategies by early next year cannot be more appropriate at this juncture.

Policy coordination within a country and across countries will clearly be important in maintaining the momentum of recovery as well as avoiding undesirable consequences from different timings of stimulus policy exits.

Note: Views expressed are the author's own.