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New IMF Managing Director Christine Lagarde Pleads for Policy Makers to Come to Their Senses

Christine Lagarde:

Don’t let fiscal brakes stall global recovery: After the crisis unfolded in late 2008, global policymakers came together to act with common purpose. Their efforts saved us from a second Great Depression….

The situation today is different from 2008. Then, uncertainty came from the poor health of financial institutions. Now, it comes from doubts about the health of sovereigns and the tricky feedback loop to banks. Then the answer was unprecedented monetary accommodation, direct support for the financial sector and a dose of fiscal stimulus. Now monetary policy is more constrained, banking problems will again have to be addressed, and the crisis has left behind a legacy of public debt…. So there are no easy answers. But that does not mean there are no options. For the advanced economies, there is an unmistakable need to restore fiscal sustainability through credible consolidation plans. At the same time we know that slamming on the brakes too quickly will hurt the recovery and worsen job prospects. So fiscal adjustment must resolve the conundrum of being neither too fast nor too slow.

Shaping a Goldilocks fiscal consolidation is all about timing. What is needed is a dual focus on medium-term consolidation and short-term support for growth and jobs. That may sound contradictory, but the two are mutually reinforcing. Decisions on future consolidation, tackling the issues that will bring sustained fiscal improvement, create space in the near term for policies that support growth and jobs. By the same token, support for growth in the near term is vital to the credibility of any agreement on consolidation. After all, who will believe that commitments to cuts are going to survive a lengthy stagnation with prolonged high unemployment and social dissatisfaction?…

Policy actions can focus on areas where the pressure is mounting tomorrow, but have little effect on demand today – such as reforming entitlements or restructuring the tax system. At the same time, short-term measures must be supportive of growth, yet economical in terms of the impact on fiscal sustainability, and can include policies supporting employment creation, advancing planned infrastructure and easing adjustment in housing markets.

Nor will spending cuts alone do the trick – revenues also must increase, and the first choice must be measures that have the lowest effect on demand….

Financial sector repair also remains essential: recapitalising and restructuring good banks, closing bad banks – and addressing the lack of transparency that clouds financial markets….

If policymakers can act boldly, act together and act now on these priorities, confidence can be restored and the recovery sustained.