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The Short-Term Deficit Isn't a Problem But a Blessing. The Long-Term Deficit Is All About Health Costs. And the Medium-Term Deficit Is Only a Problem If We Make It One

Felix Salmon Approves of Christine Lagarde of the IMF

"Leads from the front" is a dig at claims that on Libya Barack Obama has "led from behind"...


Lagarde leads from the front on Europe: Going into the Jackson Hole conference, everybody was breathlessly awaiting Friday’s speech from Ben Bernanke, which turned out to be incredibly boring. The most important speech of the meeting, by far, came on Saturday, and came from the new head of the IMF, Christine Lagarde. In decidedly undiplomatic prose she came right out and said what needed to be done:

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… the actual progress on rebalancing has been timid at best, while the downside risks to the global economy are increasing….

I’ll start with Europe…. Banks need urgent recapitalization…. 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…

The United States needs… future consolidation—involving both revenue and expenditure…. At the same time, growth is necessary for fiscal credibility…. 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 diagnosis of what needs to be done in the U.S. is spot-on…. But it’s Lagarde’s diagnosis of her native Europe which is proving highly controversial. Anonymous “officials”, quoted in the FT, rapidly said that she had it all wrong…. [But] anybody who knows anything about banking knows that the distinction between a liquidity problem and a solvency problem is not nearly as clear-cut as this makes out. Indeed, if there weren’t any worries about European banks’ solvency, then they wouldn’t have any kind of liquidity problems…. And if the markets are worried about a bank’s solvency, then that bank’s solvency is what must be addressed — perception is reality in such matters…. Where Lagarde sees a huge systemic problem, European officials, it seems, still thinks it can patch things up by triaging the worst banks and applying band-aids….

[T]he FT does manage to find a sliver of a silver lining: Lagarde, they write, “has said publicly what most policymakers have avoided addressing since the crisis began”. Maybe she’s just leading from the front, here: even if policymakers don’t embrace her position immediately, they might come round to her way of thinking as the world’s developed economies continue to stagnate and financial markets continue to fret over a possible sovereign crisis…