IMF’s Lagarde: World Econ ‘In Dangerous New Phase'; Act Now

Author: Market News International | Category: News

By Steven K. Beckner

JACKSON HOLE, Wyo. (MNI) – Sounding alarmed, the head of the
International Monetary Fund said Saturday that the world economy has
entered a “dangerous new phase” and called for urgent action to sustain
a flagging global recovery.

While advanced countries need to reduce their government debts,
they must not do so in a way that hurts their already “fragile”
economies, said IMF Managing Director Christine LaGarde, who also said
monetary policies must remain “highly accommodative.”

She said central banks should be ready to resume “unconventional”
easing measures — an obvious suggestion that more “quantitative easing”
may be needed.

Lagarde, addressing the Kansas City Federal Reserve Bank’s annual
Jackson Hole symposium, said “the global economy continues to grow, yet
not enough.”

Indeed, the former French finance minister went on to suggest that
the situation has gotten considerably worse in a speech that struck a
much more pessimistic note than that of Fed Chairman Ben Bernanke Friday

“Developments this summer have indicated that we are in a dangerous
new phase,” she declared. “The stakes are clear: we risk seeing the
fragile recovery derailed. So we must act now.”

Referring to the Group of 20’s objective of “rebalancing” the
global economy by encouraging more savings in countries with large
current account deficits and more spending in surplus countries, LaGarde
said “the actual progress on rebalancing has been timid at best, while
the downside risks to the global economy are increasing.”

“Those risks have been aggravated further by a deterioration in
confidence and a growing sense that policymakers do not have the
conviction, or simply are not willing, to take the decisions that are
needed,” she added.

What is needed, in the IMF chief’s view, is joint action to
“support growth, reduce debt, and prevent further financial crises.” She
said the world needs “a new approach — based on bold political action,
with a comprehensive plan across all policy levers, implemented in a
coordinated global way.”

But Lagarde’s prescriptions had a familiar ring.

“While fiscal consolidation remains an imperative, macroeconomic
policies must support growth,” she said. “Fiscal policy must navigate
between the twin perils of losing credibility and undercutting

“The precise path is different for each country,” she continued.
“But to meet the credibility test, each country needs a dual focus: a
primary emphasis on durable measures that will deliver savings tomorrow
which, in turn, will help to create as much space as possible for
supporting growth today — at least by permitting a slower pace of
consolidation where possible.”

Meanwhile, “monetary policy also should remain highly
accommodative, as the risk of recession outweighs the risk of
inflation,” Lagarde said. “This is particularly true as in most advanced
economies inflation expectations are well anchored; and pressures from
energy and food prices are abating.”

“So policymakers should stand ready, as needed, to dive back into
unconventional waters,” she added.

For Europe, Lagarde recommended “urgent and decisive action to
remove the cloud of uncertainty hanging over banks and sovereigns”
because “financial exposures across the continent are transmitting
weakness and spreading fear from market to market, country to country,
periphery to core.”

She listed three key steps that Europe should take:

1. “Sovereign finances need to be sustainable. Such a strategy
means more fiscal action and more financing. It does not necessarily
mean drastic upfront belt-tightening — if countries address long-term
fiscal risks like rising pension costs or healthcare spending, they will
have more space in the short run to support growth and jobs. But without
a credible financing path, fiscal adjustment will be doomed to fail.”

“After all, deciding on a deficit path is one thing, getting the
money to finance it is another. Sufficient financing can come from the
private or official sector — including continued support from the ECB,
with full backup of the euro area members.”

2. “Banks need urgent recapitalization. They must be strong
enough to withstand the risks of sovereigns and weak growth. This is key
to cutting the chains of contagion. If it is not addressed, we could
easily see the further spread of economic weakness to core countries, or
even a debilitating liquidity crisis.”

“The most efficient solution would be mandatory substantial
recapitalizationseeking private resources first, but using public funds
if necessary. One option would be to mobilize EFSF or other
European-wide funding to recapitalize banks directly, which would avoid
placing even greater burdens on vulnerable sovereigns.”

3. “Europe needs a common vision for its future. The current
economic turmoil has exposed some serious flaws in the architecture of
the eurozone, flaws that threaten the sustainability of the entire
project. In such an atmosphere, there is no room for ambivalence about
its future direction. An unclear or confused message will add to market
uncertainty and magnify the eurozone’s economic tensions.”

“So Europe must recommit credibly to a common vision, and it needs
to be built on solid foundations — including, for example, fiscal rules
that actually work,” she said.

Turning her attention to the United States, Lagarde said
“policymakers must strike the right balance between reducing public debt
and sustaining the recovery — especially by making a serious dent in
long-term unemployment.”

“A fair amount has been done to restore financial sector health,
but house price declines continue to weaken household balance sheets,”
she said. “With falling house prices still holding down consumption and
creating economic uncertainty, there is simply no room for half-measures
or delay.”

Lagarde said the U.S. needs to move on two specific fronts:

1. “The nexus of fiscal consolidation and growth … credible
decisions on future consolidation — involving both revenue and
expenditure — create space for policies that support growth and jobs
today. At the same time, growth is necessary for fiscal credibility —
after all, who will believe that commitments to cut spending can survive
a lengthy stagnation with prolonged high unemployment and social

2. “Halting the downward spiral of foreclosures, falling house
prices and deteriorating household spending. This could involve more
aggressive principal reduction programs for homeowners, stronger
intervention by the government housing finance agencies, or steps to
help homeowners take advantage of the low interest rate environment.”

In other comments, Lagarde said that “in some key emerging
economies, policies keep domestic demand growth too slow and currency
appreciation too modest, if not blocked outright — even if this is not
in their own or the global interest.”

And she said “some other emerging markets — including those that
have allowed their exchange rates to appreciate — are dealing with
threats to economic and financial stability from capital inflows.”

** Market News International **

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