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A call to arms - The world economy

2011-08-30 12:33:45

Aug 28th 2011, 4:16 by Z.M.B. | JACKSON HOLE, WY

IT IS largely a gathering of central bankers; at the outset of her speech she

apologised for not being one. Yet by far the most hard-hitting words at this

year s Jackson Hole symposium came from Christine Lagarde, the former French

finance minister and new managing director of the IMF.

The world economy, she said, was entering a dangerous new phase driven by a

sense that policymakers do not have the conviction to take decisions that are

needed. That must change, and now. Ms Lagarde laid out a bold to-do list to

support growth, including a forced capital injection into Europe s banks,

aggressive new action to deal with America s foreclosure crisis, and a broad

rebalancing of fiscal priorities.

The most headline-grabbing prescription was for Europe s banks. More capital,

Ms Lagarde argued, was essential to cutting the chains of contagion in the

euro crisis. Without it there could easily be the further spread of economic

weakness to core countries, or even a debilitating liquidity crisis . She

called for what would essentially be a European version of America s policy for

its biggest banks in 2008 a mandatory capital increase using public funds if

necessary. Those funds could come from the European Financial Stability

Facility.

America, in turn, needed to do more to halt the downward spiral of

foreclosures, falling house prices and weak household spending. Ms Lagarde

suggested more aggressive schemes to reduce mortgage principal or help

home-owners refinance at lower rates.

Echoing a theme raised by Ben Bernanke, the Fed chairman, in his speech the

previous day, Ms Lagarde argued that fiscal policy should pivot, putting in

place policies to reduce future deficits while supporting growth today. This

was not a cop-out, she argued. Growth was 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 dissatisfaction?

In America that pivot would require credible decisions on future deficit

reduction involving both tax increases and spending cuts, coupled with a focus

today on making a serious dent in long-term unemployment. In Europe, she

argued, this fiscal rebalancing, and the bigger short-term deficits it implied,

would mean more official financing for some countries. That ought to include

continued support from the ECB .

While most of Ms Lagarde s to-do list applied to Europe and America, the big

emerging economies were not let off the hook. Global rebalancing had not

advanced sufficiently , she argued, because some key emerging economies

(read China) had done too little to boost domestic demand and appreciate their

currencies. The lack of rebalancing hurts everyone , she said. Decoupling is

a myth.

All told, it was a feisty call to action around a largely sensible agenda.

Although European politicians will bristle at the thought of forced capital

injections, many European banks do need a lot more capital and, so far, have

done far too little to secure it themselves. Fiscal austerity should be

recalibrated on both sides of the Atlantic. But just as important as what Ms

Lagarde said was the fact that she said it. Her stern words for Europe assuaged

worries that a former French finance minister would be too cosy with her

erstwhile colleagues. No other top policymaker has spoken so bluntly about the

risks to the world economy or called so bluntly for a co-ordinated plan to

address them. Now the question is whether governments will listen to her.

(Picture credit: AFP)