IMF chief urges action to avoid ‘1930s moment’
Tuesday, 24 January 2012 | 00:00
The chief of the International Monetary Fund warned on Monday that the global economy could slide into a "1930s moment" unless Europe deals with its debt crisis and other economic powerhouses such as the U.S. and China fulfill their responsibilities.
Christine Lagarde called for stronger growth, larger firewalls and deeper integration in the euro zone to stem the crisis after the “many false starts and half measures” seen in 2011. She delivered this stark message in Berlin, the capital of Germany — Europe’s biggest economy and the most important player in resolving the long-running crisis.
Her remarks come ahead of the World Economic Forum’s annual meeting in Davos, Switzerland, which begins on Wednesday and ahead also of the Jan. 30 summit of European Union leaders in Brussels.
“What we must all understand is that this is a defining moment,” Lagarde said at the German Council on Foreign Relations, according to the prepared text of her speech. “It is not about saving any one country or region. It is about saving the world from a downward economic spiral. It is about avoiding a 1930s moment, in which inaction, insularity and rigid ideology combine to cause a collapse in global demand.”
The “1930s moment” appears to be a reference to the Great Depression of the 1930s, when the crash on Wall Street in 1929 triggered an economic depression in the U.S. which later spread around the world.
Lagarde said the IMF will lower growth forecasts for most parts of the world in the economic outlook it’s due to release on Tuesday.
The turbulence seen in 2011, the IMF chief said, stemmed from “a lack of a collective determination to reach a cooperative solution” both in Europe with the debt crisis and in the U.S. with the debt-ceiling debacle.
Lagarde expressed hope that a 1930s scenario can be avoided: “That is my core message to you today — although the economic outlook remains deeply worrisome, there is a way out,” she said. “Now the world must find the political will to do what it knows must be done.”
Lagarde argued that the IMF’s lending capacity must be stepped up. The fund is aiming to raise up to $500 billion in additional lending resources based on its estimate of a global potential financing need of $1 trillion in the coming years.
The euro zone’s role
Lagarde, who previously served as France’s finance minister, addressed in detail the situation in the euro zone and was careful to acknowledge the major steps the region has already undertaken to fight the crisis, including the creation of the euro-area bailout fund and the European Central Bank’s decision to provide long-term liquidity to banks.
She emphasized, however, that much remains to be done in Europe in order to boost growth, build bigger firewalls and deepen integration.
On growth, Lagarde said that additional and timely monetary easing will be important to reduce the risk of inflation falling well below target next year.
And she warned that Europe-wide budgetary cuts are adding to recessionary pressures, so the countries “with fiscal space should support the common effort by reconsidering the pace of adjustment planned for this year.”
Germany is among the euro-zone countries with the biggest “fiscal space,” but it’s also the one that has pushed aggressively for austerity measures and budget cuts in the debt-laden peripheral nations as a way to rectify their public finances. Lagarde also called for a larger firewall against the crisis, another idea that may be resisted in Germany, where there is growing opposition to pouring more money into bailing out the periphery.
“We need a larger firewall,” Lagarde said. “Without it, countries like Italy and Spain, that are fundamentally able to repay their debts, could potentially be forced into a solvency crisis by abnormal financing costs. This would have disastrous implications for systemic stability.”
“Adding substantial real resources to what is currently available by folding the EFSF into the ESM, increasing the size of the ESM, and identifying a clear and credible timetable for making it operational would help greatly," she noted. The EFSF, or European Financial Stability Facility, is the euro zone’s current bailout fund that will be replaced by the permanent ESM, or European Stability Mechanism.
Lagarde also called for deeper fiscal integration, saying that “it is not tenable for 17 completely independent fiscal policies to sit alongside one monetary policy.” While the ECB sets monetary policy for the euro zone, each nation inside the area has an independent fiscal policy, though last December members committed to a so-called compact on fiscal rules.
But Lagarde urged the euro zone to go further and adopt some form of fiscal risk-sharing, such as the creation of euro-area bonds or a debt redemption fund. “Political agreement on a joint bond to underpin risk sharing would help convince markets of the future viability of European economic and monetary union,” she said.
In her speech, the IMF head also talked about the important role other economies need to play, including the special responsibility of the U.S., the world’s largest economy.
“Yes, it is recovering, but at a timid pace, and unemployment — while declining — remains unacceptably high,” Lagarde said about the U.S. economy. “The key policy priorities must be to relieve the burden of household debt and to deal decisively with the issue of public debt.”
She also urged China to continue to shift growth away from exports and investment toward consumption.