IMF warns Europe and US over debt crises

The new head of the International Monetary Fund (IMF), Christine Lagarde, warned policymakers in Europe and America on Tuesday that failure to get to grips with their debt crises would lead to fresh turmoil in the global economy.

Speaking in New York, the former French finance minister said that turbulence could “easily resurface” in the eurozone despite the positive response in the financial markets to last week’s bailout package.

Lagarde also made it clear to bickering Democrats and Republicans in Washington that there would be knock-on effects for the rest of the global economy if there was no agreement on raising the US debt ceiling.

“I’m hopeful that the political courage shown by European leaders will soon be followed by bold fiscal action in the US,” Lagarde said. “On the debt ceiling, the clock is ticking, and clearly the issue needs to be resolved immediately. Indeed, an adverse fiscal shock in the United States could have serious spillovers on the rest of the world.
But more fundamentally, a credible fiscal adjustment plan is needed sooner rather than later.”

Noting that the financial and economic crisis of 2008-09 had left “deep and long-lasting scars”, the IMF managing director said America should be careful not to raise taxes or cut spending too quickly.

“The United States could be facing another jobless recovery. Again, that’s why we’ve advised against fiscal consolidation that is unduly hasty—even as we stress the importance of getting a fiscal consolidation plan agreed soon. We’ve also recommended active labour market policies to stem the rise in structural unemployment, and measures to ease adjustment in the housing market [for example, mortgage relief].”

Economists at the fund have estimated that a 1% cut in the budget deficit lowers growth by half a percentage point over two years.

Recovery more robust
“This is why measures that are legislated now—but only reduce deficits in the future, when the recovery is more robust—would be particularly helpful,” Lagarde said. “But there is good news too: over the longer term, debt reduction can actually raise output by bringing down real interest rates and making room for tax cuts.”

She added that the fiscal problems affecting countries on the periphery of the eurozone had “revealed the risks posed by an incomplete economic and monetary union. As a result, the euro area as a whole is experiencing difficulties. Even the tough fiscal and structural measures adopted by the affected countries have not convinced markets that a lasting solution is in place.

“The agreement shows that European leaders believe in the eurozone, and will do what it takes to secure its destiny. It has been welcomed by financial markets, as reflected in the stronger euro and lower peripheral bond spreads. But turbulence could easily resurface. For this reason, it is essential that the summit’s commitments should be implemented quickly.”

Lagarde also warned of the dangers of social instability, which contributed to the political upheaval in the Middle East and North Africa.

“Social problems are of major concern to advanced economies too,” she said. “The young in particular are having a hard time finding work—with potentially lifelong implications in terms of employability and income. At the same time, the older generations are fighting to protect their health and pension benefits. Combine the two, and we may face a ‘clash of generations’, to borrow a term coined by the scholar David Rothkopf. This is why focusing on the right kind of growth is so important.”— Guardian News and Media 2011

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