Bernanke faced with tricky balancing act

In New Zealand how the central bank will take back the monetary policy stimulus it put in place during the financial crisis is relatively straightforward. Governor Alan Bollard will raise the official cash rate from its historic low of 2.5 per cent and the only debate is whether he will start in April, June or later.

In the United States it is much more complex, because the traditional policy rate, the federal funds rate, was cut to zero early in the crisis and subsequent monetary stimulus has mainly taken the form of quantitative easing, with the Federal Reserve massively expanding its balance sheet through the purchase of a range of securities.

The effect was to leave the US banking system in a highly liquid state, with banks holding more than US$1 trillion ($1.4 trillion) of reserves with the Fed.

Now Fed chairman Ben Bernanke has spelled out in considerable detail how - but not when - the exit strategy from this easing will work. The market had been calling for that guidance.

The Federal Reserve is also considering, as a transitional measure, using an alternative short-term interest rate, like the rate it pays on reserves, as a guide to its policy stance, instead of the Fed funds rate - the rate at which banks lend to each other overnight.

Bernanke stressed that he was not signalling a change from the very loose monetary policy now in place, repeating the Fed's mantra that conditions "are likely to warrant exceptionally low levels of the federal funds rate for an extended period".

The International Monetary Fund late last month said that with unemployment high and inflation low many central banks could afford to keep interest rates low over the coming year.

"At the same time credible strategies for unwinding monetary policy support need to be prepared and communicated now ... to dampen potential fears of inflation or renewed financial instability," the IMF said.

AXA Global Investors chief economist Bevan Graham said 2010 would be the "year of the great unwinding".

Countries would embark on their exit strategies at different times. China and Australia already had.

"We will probably be next, but the United States and United Kingdom quite a bit later," Graham said.

"The market is in general quite jittery at the moment about how to think about this year and there is a bit of confusion about what is a good signal and what is not."

The recovery would be hard work, he said, and the nature of the recovery needed to be different this time around, given the size of the imbalances that had built up before the crisis.

"In the US - and New Zealand for that matter - we want consumption to lag the recovery this time, not lead it."

So the weakness of consumption growth, and the relative strength of business investment and net exports, in the latest US GDP figures was exactly what he would want to see.

The IMF has revised up its forecasts for world growth this year but warned that there were still few indications that "autonomous" private demand was taking hold.

Westpac chief economist Brendan O'Donovan expects an upturn to come sooner and be stronger in the United States than in Europe.

"But they still have an extremely high unemployment rate, plenty of spare capacity, fragile financial markets ... so they would not want to do anything that would jeopardise the recovery getting into a self-sustaining mode."