The Exit Challenge

The monetary policies in response to the financial crisis demonstrated that changes in central bank balance sheets have major macroeconomic consequences. The New Classical Macroeconomics, which gained increasing sway from the late 1980 and which led to an exclusive focus on the policy rate that was not warranted, had simply assumed away such effects (Ricardian equivalence). Getting their balance sheets back to normal levels is important in order to preserve policy flexibility for the future and will present central banks with some formidable challenges. This task will require cooperation with Treasuries without surrendering monetary policy independence. While central banks must be entirely pragmatic in their monitoring of market resilience, they must beware of the “financial dominance” trap.