With the world economy on a path of recovery, banks around the world are starting to wrap-up emergency monetary-policy measures. Some have begun to raise benchmark interest rates, and many more are expected to follow this year. All this at a time when the recovery in many economies remains shaky will be tricky, and a capricious exit from expansionary policies might lead to macroeconomic and financial-market turmoil.
The normalization of monetary policy presents two broad category risks on a macro-level. The first and the most ominous is that policymakers in key economies will miss the boat: tightening too much, too little or doing it at the wrong time. Capping supportive policies before the economy is able to get back on its feet could impede the recovery process. and if this were to occur in the developed countries, it would imperil global GDP growth.
The second is that differences in the speed and magnitude of policy tightening between different countries could create disruptive imbalances, for instance, leading to speculative bubbles in high-risk assets, which could, in turn, lead to new financial crises in some countries.
It is also known that the global monetary-policy divergences always exist to a certain extent, as economies grow and contract at different rates and as central banks and markets respond accordingly. However, this one is particularly a very critical time the global economy is now more vulnerable as a result of its worst downturn in decades.
Policy mistakes might have irreparable negative consequences, so extreme care needs to be taken while addressing this.