|IMF managing director Christine Lagarde in Peru, Nov 28, 2011
managing director Christine Lagarde today called on the international community
to take urgent collective action to save the world economy from a downward
spiral. She also said the Eurozone needed a bigger firewall to prevent Italy and
Spain sliding towards default.
“The longer we wait, the worse it will
get. The only solution is to move forward together. Our collective economic
future depends on it,” Lagarde said in
a speech at the German Council of Foreign Affairs in Berlin.
“Looking at it from this perspective, 2012 must be a year of healing.”
She laid out the main elements of a policy path
forward. Europe, which is at the centre of global concerns, needs stronger
growth, larger firewalls, and deeper integration, she said, but added that other
economies also have an important role to play to restore balanced global growth.
As for the multilateral component, Lagarde said that the IMF was ready to help
and was seeking to increase its lending resources by up to $500bn.
We must all understand that this is a defining
moment. It is not about saving any one country or region. It is about saving the
world from a downward economic spiral, she said.
The IMF estimates that in coming years,
additional global financing of potentially $1 trillion could be needed, which
the Fund can help meet with additional lending resources. “A cooperative path
means that all countries must work together with a common diagnosis toward a
common solution,” Lagarde said, adding that the Fund can push for such a
cooperative outcome through its analysis and policy advice, but also help by
providing financing when needed.
“I am convinced that we must step up the
Fund’s lending capacity,” she said. The goal here is
to supplement the resources Europe will be putting on the table, but also to
meet the needs of other countries, anywhere in the world, affected by the
repercussions of the crisis, she added. Eurozone countries have already pledged
to provide up to $200bn in new financing for the IMF.
Addressing the crisis in the Eurozone
The leaders of the 17 Eurozone countries have
already taken a number of important steps to stem the sovereign debt crisis that
has undermined confidence in the world’s financial markets, Lagarde said.
Major achievements include the establishment of
the European Financial Stability Facility (EFSF)/European Stability Mechanism
(ESM), agreement on a harmonized approach to recapitalize banks and the
establishment of a systemic risk board, governance reforms to enforce stronger
and more effective fiscal discipline, and the European Central Bank’s decision
to make long-term liquidity available to banks.
“These major steps must be recognized.
Yet I would not be the first to argue that these moves form pieces, but pieces
only, of a comprehensive solution,” she said.
Three imperatives are needed to fully restore
confidence: stronger growth, larger firewalls, and deeper integration.
With the euro area economy slowing sharply,
inflation is already declining. This creates a sizable risk that it will fall
well below target next year, raising debt burdens and further hurting growth.
For this reason, additional and timely monetary easing will be important to
reduce such risks, Lagarde said.
“Stronger growth also means preventing
banks from going into reverse gear, contracting credit in the face of market
pressure. Solutions should focus on raising capital levels—rather than cutting
back lending - - as the way to boost capital ratios,”
With respect to fiscal policy, several
countries have no choice but to tighten their finances sharply and quickly. But
this is not true everywhere, Lagarde said. “There is a
large core where fiscal adjustment can be more gradual.”
Also of paramount importance are structural
reforms to lay the groundwork for boosting competitiveness and long-term growth.
Lagarde also called on European policymakers to
create a larger firewall. 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 funding costs -- a development she warned
would have disastrous consequences 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 said.
Action by the ECB to provide the necessary
liquidity support to stabilize bank funding and sovereign debt markets would
also be essential.
“We must also break the vicious cycle of
banks hurting sovereigns and sovereigns hurting banks,”
she said. “This works both ways. Making banks stronger,
including by restoring adequate capital levels, stops banks from hurting
sovereigns through higher debt or contingent liabilities. And restoring
confidence in sovereign debt helps banks, which are important holders of such
debt and typically benefit from explicit or implicit guarantees from
Lagarde also called for more risk sharing across
borders in the banking system to break the feedback loop between sovereigns and
banks. “In the near term, a pan-euro area facility that has the capacity to
take direct stakes in banks will help break this link,” she said. Further
financial integration in the form of unified supervision, a single bank
resolution authority, and a single deposit insurance fund is also necessary.
“The euro area also needs greater fiscal
integration - - it is not tenable for seventeen completely independent fiscal
policies to sit alongside one monetary policy,” she
added. The “fiscal compact” that was agreed at the summit of European
leaders in early December 2011 needs to be complemented by some form of fiscal
risk-sharing. A number of financing options are available to support such risk
sharing, including the creation of euro area bonds or bills or, as proposed by
the German Council of Economic Advisors, a debt redemption fund, she said.
The rest of the world must do its share
While Europe is at the epicentre of the current
crisis, other economies also have an important a role to play in helping secure
a better outcome.
The United States, as the world’s largest economy
and the centre of the global financial system, has a special responsibility,
Lagarde said. She called on US policymakers to relieve the burden of household
debt through programs to make mortgage debt sustainable and to act decisively to
bring down tomorrow’s deficits without bringing down today’s economy.
As the world’s third largest economy, Japan must
also play its part by putting in place a credible plan to bring down public debt
and reforms to raise long-term growth.
Lagarde also called on both emerging and advanced
countries with large current account surpluses to encourage more domestic demand
as a way to support global growth. China, which has the world’s largest foreign
currency reserves and runs a large current account surplus, is a case in point.
“China can help itself and the global economy by continuing to shift growth away
from exports and investment, toward consumption,” she said.
Lagarde concluded that while the economic
outlook remains deeply worrisome, there is a way out.
“Now the world must find the political will to do what it knows must be done.”
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