The world seeks an exit strategy

In his first term chairing the Federal Reserve, Ben Bernanke won the nickname "Helicopter Ben" for his willingness to shower money on the markets, as he tried to put out fires in the credit crisis. Second-term Ben will need a new nickname, because the next order of business is pulling all that money back out of the system.

Mr Bernanke is due on Capitol Hill today to outline some of the tools at his disposal, his contribution to the burgeoning worldwide debate about "exit strategies". For governments that have loosened the fiscal purse strings to pay for economic stimulus packages, just as for central banks that printed money to bring down interest rates, these are vital and controversial questions. The pressures vary from country to country, but a burgeoning army of exit strategists must answer two questions: not just "when?", but "how?".

In the US, the Obama administration is taking a similar approach to fiscal policy as it is to the war in Afghanistan: a surge now, followed by a commitment to begin pulling out in 2011. There will be more economic stimulus this year (this time a $100bn "Jobs Bill"), plus a promise to freeze spending and cut the deficit next year. It is a tricky balancing act, a high wire between Republican fears that the national debt is dangerously high, and Democratic fears that the economy is dangerously weak.

For Mr Bernanke, exit strategies are also fraught, with the added complication that any move could have amplified consequences across fragile financial markets. The US banking system has been rejuvenated because institutions have been able to borrow from the Fed at effectively no cost, turning all the interest they get from customers into profit. A gentle move to raise rates could thus have a disproportionate effect on banks' capitalisation.

The Fed's balance sheet, meanwhile, has swollen from a pre-crisis $600bn to more than $2 trillion, and it is using newly printed money to buy $1.25 trillion of mortgage-backed securities in order to hold down home loan interest rates. But the US housing market is not yet unequivocally on the up, so selling these securities back into the market seems unlikely to be an early part of the exit strategy. Neither does selling the $300bn of US Treasuries that the Fed purchased in another example of quantitative easing last year, though the New York branch of the Fed has been researching the market impact of potential sales with a number of small trial runs in recent months.

"The Fed has to undertake this process gradually," says John Lonski, US economist at Moody's Investors Service. "I think it is a bit too early to be putting energy into debating exit strategies; we are yet to normalise the credit markets and there is still an insufficient supply of credit."

In front of the House Financial Services Committee, Mr Bernanke will major on "how?", and keep his counsel on the "when?". At least the Fed chair can boast he has plenty of levers to pull, when the time is right. One in particular is crucial. Congress last year gave the Fed permission to pay interest on the reserves that financial institutions leave at the central bank. The first move in the exit strategy could be to raise that rate from its current 0.25 per cent, which the Fed thinks will be an effective way to push up rates across the range of credit markets.

But much is out of Mr Bernanke's hands. If Europe's central banks end their loose monetary policy, that could strengthen their currencies at the expense of the dollar and stoke inflation in the US, which might force his hand into tightening policy early.

UK: A weak recovery but no money left to pay for additional help

Britain's decision on when to begin withdrawing fiscal and monetary policy boosts to the economy is not being taken from a position of strength. With economic growth of just 0.1 per cent in the final quarter of last year, it is clear that in an ideal world, economists and politicians would like to carry on boosting the recovery for the foreseeable future. But against that must be balanced the fear that public debt is becoming unsustainable.

Indeed, while the political game of insult-swapping continues – "you would cut, we would invest", "you're irresponsible, we're not" – the UK is already being weaned off life support. The temporary reduction in the VAT rate was reversed at the beginning of the year, while the scrappage scheme, providing a boost to the car industry, is now drawing to a close.

The Bank of England, meanwhile, has suspended its quantitative easing programme and economists expect the next move in interest rates to be up rather than down, though not before the second half of 2010 at the earliest.

That said, public spending cuts, other than mild retrenchment to appease the markets, are unlikely this year, whoever wins the election. And while some tax rises will kick in in April, the fiscal tightening begins in earnest in April 2011.

Europe: Mixed fortunes make for hard debate

The eurozone may have one currency, but it is deeply divided on economic policy. On the one hand, countries such as Greece, Portugal and Spain are barely out of recession – or still in downturn, in the latter's case – but under huge pressure to improve their public finances while on the other, Germany, from a position of relative economic strength, is keen to pare back. Broadly in the middle sits France, which accepts the need for a return to the strict rules on borrowing that once ruled the single currency area – borrowing capped at 3 per cent of GDP annually – but believes the pruning must be done with some patience.

The European Central Bank, meanwhile, which has been consistently less aggressive than the Bank of England on monetary easing, now wants to cut back on its emergency lending to the financial sector, though the Greek crisis may make that more difficult.

Japan: The curse of Japanese deflation continues – with no end in sight

Japan is less far advanced on the move to unwind fiscal and monetary support packages than any other developed economy in the world. Indeed, amid fears that a return to recession is a real danger in the months ahead, with unemployment at record highs and no sign of any improvement in consumer spending, Japan's parliament has been debating whether to introduce a third round of fiscal stimulus measures.

The Bank of Japan is equally determined not to deviate from its course of easing, with deflation continuing apace so far this year. Though the Bank does not share the more gloomy forecasts of a return to recession this year, it is predicting prices will continue to fall, which makes a change of monetary policy unlikely.

China: No longer willing to prop up the global economy

A $586bn (£373bn) package of government infrastructure, training and research spending helped prop up not just China's economy but also optimism about world trade last spring, but the Communist regime has now unequivocally entered "tightening" mode. The economy was growing at a 10.7 per cent annual rate by the end of 2009, and the stock market had leapt 80 per cent on the year, leaving rulers concerned that banks had begun to make frothy investments in the stock market and in real estate.

Prime Minister Wen Jiabao said he wished bank lending last year had not reached the $1.4 trillion that it did.

With signs that it was accelerating rather than slowing, some state-owned institutions were told to stop making new loans halfway through January, and there have been local reports of infrastructure projects being cancelled. It was these reports that sparked a sell-off by Asian stock markets at the end of last month.

The Chinese central bank has also so far this year hiked a key lending rate and demanded that banks put aside more reserves against potential bad loans – all measures designed to crimp the bank lending spree that fuelled last year's economic expansion.

India: A budget to rein in price increases

The price of lentils, rice and other basic foods is rising at an annual rate of 17.6 per cent in India. Potatoes are up 44 per cent. The soaring prices have put inflation at the top of the list of political issues and piled pressure on the government to rein in the fiscal and monetary stimulus with which the economy was dosed last year. The country's central bank governor, Duvvuri Subbarao, has begun to pull some of the $125bn in extra liquidity in the system, demanded higher capital reserves at banks, and is widely expected to push up interest rates without waiting for the next scheduled policy meeting in April. He has also urged the government to mirror these efforts with spending cuts, in part to get a grip on a deficit that will pass 10 per cent of GDP this year. The government's next budget, due later this month, is likely to be highly contentious.

Australia: Last in and first out

Having weathered the slowdown better than any other developed nation, Australia was the first economy to begin tightening monetary policy, and has announced three interest rate increases since October. The Reserve Bank of Australia surprised economists by leaving rates on hold at 3.75 per cent last week, but said it expected to impose further increases later this year.

After boosting the economy in 2008 and 2009, the government has also begun to cut back its fiscal stimulus programmes, stopping, for example, grants for homebuyers, though higher public infrastructure spending is continuing.