Financial markets are focusing on the potential exit from the expansionary fiscal and monetary measures, low or zero interest rates and quantitative easing that policy makers have relied on to engineer a recovery.
Central banks believe they will be able to exit when appropriate, reminiscent of Ashly Lorenzana's definition of addiction in her journal Sex, Drugs & Being an Escort: "When you can give up something any time, as long as it's next Tuesday." In reality, these policies may be hard, if not impossible, to reverse.
The difficulty of an exit is complicated by the size of the intervention as well as the fact that economic activity and financial markets are heavily reliant on these support measures.
In the US, it now requires a government budget deficit of about $600bn, augmented by injection of about $1tn in liquidity from the Federal Reserve, to create about $300bn of growth. Since 2008, the balance sheets of big central banks have expanded from about $5tn-$6tn to more than $18tn. In many developed countries, central bank assets now constitute between 20 per cent and 30 per cent of gross domestic product.
As the European evidence highlights, withdrawing fiscal stimulus would lead to sharp slowdowns in economic activity. Slower growth would make it difficult to correct budget deficits and control government debt levels, increasing the risk of a crisis or forcing reliance on central bank financing.
David Fuller's view This is one of the more pessimistic comments that I have seen regarding the ending of quantitative easing in the US.
We have heard a wide range of opinions on this subject but there is no denying that a reduction in QE will represent the beginning of a tightening in monetary policy, albeit from its historically accommodative levels. This will be occurring against the background of moderately expensive stock markets, at least relative to their levels of last November, when the recent strong rally commenced. There is the additional issue of Mr Bernanke's departure from the Fed, although the actual date has yet to be confirmed.
I think the longer-term outlook for stock markets is quite bullish, but Fullermoney has often mentioned that the next significant gains may not be seen before the removal of the Fed's QE has occurred. Meanwhile, we expect further ranging over the medium term, with the possibility of some temporary downward reactions.