IMF Update: Speech from Christine Lagarde (IMF) at Jackson Hole

IMF Update: Speech from Christine Lagarde (IMF) at Jackson Hole

AUGUST 27TH, 2011


“Global Risks Are Rising, But There Is a Path to Recovery”: Remarks at
Jackson Hole

By Christine Lagarde
Managing Director,

International Monetary Fund
Jackson Hole, August 27, 2011

As prepared for delivery

Let me first thank Tom Hoenig for inviting me to participate in this remarkable conference in Jackson Hole. Tom has served the Federal Reserve System with great distinction, and has made a significant contribution to economic and monetary policy discussion. And let me also recognize my friend John Lipsky who, after five years of distinguished service as First Deputy Managing Director of the IMF, will be stepping down—and who has been so generous in giving up his speaking slot to me today.

Listening to the many wise voices here over the last day or so, I
am struck by several salient themes. The global economy continues to grow, yet
not enough. Some of the main causes of the 2008 crisis have been addressed, yet
not adequately. There remains a path to recovery, yet we do not have the luxury
of time.

Two years ago, it became clear that resolving the crisis would
require two key rebalancing acts—a domestic demand switch from the public to the
private sector, and a global demand switch from external deficit to external
surplus counties. On the first, the idea was that strengthened private sector
finances would allow the engine of growth to switch back from the public to the
private sector. On the second, the idea was that higher demand in surplus
countries would make up for a lower spending path in deficit countries. But 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.

Developments this summer have indicated that we are in a
dangerous new phase. The stakes are clear: we risk seeing the fragile recovery
derailed. So we must act now. It is a matter of vision, courage and timing.
Decisive action will bolster the confidence that is required to restore and
rebalance global growth.

We are not without options. We know what needs to be done to support growth, reduce debt, and prevent further financial crises. But we need a new approach—based on bold political action, with a comprehensive plan across all policy levers,
implemented in a coordinated global way.

The balance sheet problem

As we all know, a major cause of the crisis was too much
debt and leverage in key advanced economies. Financial institutions engaged in
practices that magnified, disguised and fragmented risk, while
households borrowed too much. Experience tells us that these excesses (combining
both housing and financial crises) take a long time to work off—and require
decisive action. We have made some progress, but not enough to unshackle
growth.

I am by no means downplaying what has been done. In 2008,
governments took bold action to prevent a calamitous collapse in demand. They
offset private contraction with fiscal expansion and used public resources to
recapitalize financial institutions. They strengthened financial regulation, and
reinforced the capacity and resources of international institutions. And
monetary authorities did their part as well.

But today, it is publicsector balance sheets themselves that are in the firing line. Today, the headline problems are sovereigns in most advanced economies, banks in Europe, and households in the United States. Adding to this—global growth is also being held back by policies that slow demand in some key emerging market economies while balance sheet risks are increasing in others.

The fundamental problem is that in these advanced economies, weak growth and weak balance sheets—of governments, financial institutions, and households—are feeding negatively on each other. If growth continues to lose momentum, balance sheet problems will worsen, fiscal sustainability will be threatened, and policy
instruments will lose their ability to sustain the recovery.

The policy agenda

What should be done? Clearly, the scope for policy action is much narrower today than in 2008. There are no easy solutions, but that does not mean there
are no solutions.

Put simply, while fiscal consolidation remains an imperative, macroeconomic policies must support growth. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery. The precise path is different for each country. 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. For
instance—measures that change the rate of growth of entitlements, health or
retirement.

Monetary policy also should remain highly accommodative, as
the risk of recession outweighs the risk of inflation. This is particularly true
as (i) in most advanced economies inflation expectations are well anchored; and
(ii) pressures from energy and food prices are abating. So policymakers should
stand ready, as needed, to dive back into unconventional
waters.

Micro-level policy actions to relieve balance sheet pressures—felt by households, banks, and governments—are equally important. We must get to the root of the problem. Without this, we will endure a painful and drawn-out adjustment process. Structural reforms will surely help boost productivity and growth over time, but we should take care not to weaken demand in the short term.

While we can all agree on the broad brushstrokes of what needs to be done, the devil is always in the details. I would like to delve deeper into the different problems of Europe and the United States.

Europe

I’ll start with Europe. Here, we need urgent and decisive action to remove the cloud of uncertainty hanging over banks and sovereigns. Financial exposures across the continent are transmitting weakness and spreading fear from market to market, country to country, periphery to core.

There are three key steps that Europe should take.

First, 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.

Second, 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 recapitalization—seeking 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.

Third, 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.

The United States

In the United States, 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. With falling house prices still holding down
consumption and creating economic uncertainty, there is simply no room for
half-measures or delay.

So the United States needs to move on two specific fronts.

First—the nexus of fiscal consolidation and growth. At first blush, these challenges seem contradictory. But they are actually mutually reinforcing. 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 dissatisfaction?

Second—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.

The global dimension

Stepping back to a global perspective, as I said at the outset, rebalancing has not advanced sufficiently, despite the slow growth in deficit countries. 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. 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.

So the lack of rebalancing hurts everyone, while at the same time, everyone should recognize that decoupling is a myth. If the advanced countries succumb to recession, the emerging markets will not escape.

As we take a global perspective, we should not—and cannot—forget the low-income countries, where populations are especially vulnerable to economic dislocation in the rest of the world. These countries need to focus on protecting themselves from future storms—including by rebuilding policy buffers and investing in social safety nets. The international community, of course, must stand ready to help.

Conclusion—Risks rising, but path to recovery In sum, risks to the global economy are rising, but there remains a path to recovery. The policy options are narrower than before but there is a way through. There are lingering uncertainties, but resolute action will help to dispel doubts.

I am confident that with the right actions, strong, sustainable, and balanced growth
can and will be restored.

As in the first phase of the crisis, we have reached a point where actions by all countries, doing what they can, will add up to much more than actions by a few.

There is a clear implication: we must act now, act boldly, and act together.

I can assure you that for its part, the IMF will continue to do everything in its power to advocate for this outcome, and to lend its material support wherever it is requested and
relevant.

Thank you.

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