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Why do we need an exit strategy for the economy?

We have to get out of the recession, but we have to make sure we do it in the right way.
Sept 26,2009
Korean Finance Minister Yoon Jeung-hyun is greeted by U.S. Treasury Secretary Timothy Geithner as he arrives at the leaders reception of the G-20 Summit in Pittsburgh, Pennsylvania, on Thursday. They and their counterparts from the other G-20 member countries discussed international cooperation in future exit strategies. [AP]
Dear teen readers, does the word “exit strategy” ring any bells? Those of you who regularly read the newspaper or watch the news may already have noticed that the phrase pops up in the media every day. Most of you are aware of the economic downturn, which has already caused problems for parents everywhere. They may be worried about whether they can afford the tuition and textbooks for your late-night cram school, or the college tuition they will have to pay once all of your studying has paid off and you are admitted to the university of your choice.

Since earlier this year, the economic downturn, which started last year, has been showing increasing signs of abating. Local companies’ earnings are soaring to levels unseen since the recession kicked into full gear last September, and consumer sentiment indices are improving to post-crisis levels. The lagging unemployment rate is still a big problem, but there is a growing consensus among experts and economic policy makers that the worst is finally behind us.

But that does not mean that we can sit back, relax and wait until the economy gets back on its feet. The sad truth is that economic recovery does not come about without well-planned and well-coordinated efforts. We have to emerge from the recession, but we have to do it in the right way. Otherwise, we will be faced with equally daunting problems in our post-crisis days, one of the worst of which is rampant inflation.

In other words, even if the economy recovers to the point where your parents can afford to pay for your school textbooks and college tuitions at the current rates, inflation will push the costs of those things even higher. The pace of the increase will be so fast that people won’t be able to keep up. Obviously, this is not a desirable situation for anyone. That is why we need exit strategies to get us out of the recession, so we can continue to live well for a long time to come.

Of all the other economic downturns the world has experienced in the past, the current recession is particularly difficult. The process of coming out of it requires extremely careful planning, or we could tip the balance the wrong way and end up back in the place where we began.

Governments around the world have pumped a huge amount of money into the private sector over the past few months to stimulate their ailing economies and salvage their struggling financial systems. That means there is an enormous amount of money in circulation in Korea, Japan, the United States and any other country that has implemented an economic stimulus plan.

As you have probably learned, the increase in the supply of money eventually pushes up the prices of food, transportation, books, clothes and just about everything around us. That means that a head of cabbage that cost $4 at a grocery in January now costs $8, and a school textbook priced at $10 last November is now $18. These sharp price increases are exactly what policy makers and economic experts around the world are afraid of, after having released such a large amount of money into the financial system in 2008 and 2009.

Another problem is that governments cannot sustain such costly stimulus plans forever. They need to recover their money in order to keep things running smoothly. And that is why finance ministers, central bank governors and political leaders around the world are having near daily debates on whether governments need to devise joint exit strategies and, if so, when and how they will be carried out.

The phrase “exit strategy” dominated the G-20 meeting in Washington, D.C., in April, and was discussed by finance ministers and central bankers from advanced countries. Back then, a small number of policy makers and economic observers who had noticed signs that an economic recovery was near started to talk about the right way to get out of the recession. However, the talks were largely dismissed as being untimely.

Now, the world’s major markets are experiencing a red-hot bull run unlike anything that’s been seen for months, while data from the U.S. housing market, the epicenter of the whole credit debacle, appears better than expected. Consumer sentiment is on the mend, and many leading companies posted better-than-expected profits in the first and second quarters.

Is now the right time to talk about exit strategies? Maybe, or maybe not, depending on you who you’re talking to. German Finance Minister Peer Steinbrueck said last month the G-20 needs to work towards a “clear and binding commitment to reduce public deficits” and prevent the buildup of inflationary pressure.

But not everyone shares Steinbrueck’s concerns. Some of his overseas peers are have expressed the fear that putting an end to expansionary measures at this point could snuff out the slight flicker of hope they had managed to revive while also dampening the nascent signs of economic recovery.

British Chancellor of the Exchequer Alistair Darling said he is “less concerned” about implementing an exit strategy too late than doing it too early, emphasizing that the biggest single risk with recovery efforts is that “people think the job is done.”

U.S. Treasury Secretary Timothy Geithner expressed similar sentiment, saying the “dominant challenge” at the moment is ensuring a durable recovery.

Indeed, the first step in any economic exit strategy would be to call in all the money the government filtered into the financial system, which means the flood of money that once washed into the system will be sent back to the central banks. Doing so will reduce the amount of money in circulation and help nip inflation in the bud. But there is also a risk that it could deliver a blow to an economy on the verge of recovery. The reduced supply of money will eventually push up common interest rates, which means that companies hoping to borrow money to reopen their once-dormant production plants and finance their new projects will have more difficulty getting a loan. That is why people like Geithner, Darling and even Korean Finance Minister Yoon Jeung-hyun are so reluctant to launch an exit strategy.

Central bankers around the world, including Bank of Korea Governor Lee Seong-tae, are increasingly nervous about emerging signs of inflation, because preventing inflation is the main goal of the central banks.

In particular, it has been proven that whenever Koreans have an ample amount of cash, they rush to buy more houses, land and real estate properties, which is exactly what’s happening right now. The cash the government released to the banks is now flowing into the real estate market rather than to the cash-strapped companies that need it most, pushing up once-stagnant housing prices.

All of this is making financial regulators in Seoul nervous because they are afraid the real estate bubble of the mid-2000s could return.

Many believe that the easiest way to curb the increase in local housing prices may be to tighten current expansionary efforts and stop pouring money into the system.

By Jung Ha-won [hawon@joongang.co.kr]