"Global Challenges in 2012" By Christine Lagarde, Managing Director, International Monetary Fund

IMF News, January 23, 2012

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Authors: Christine Lagarde
Published: January 23, 2012

Overview and context

Speech delivered in Berlin, January 23, 2012; "As prepared for delivery."
Theme: 2012 must be "a year of healing" after a turbulent 2011 driven by a lack of collective determination to reach cooperative solutions.
Key risks highlighted:
- Uncertain economic prospects, dwindling job opportunities, and rising inequality.
- Legacy of high public and private debt hurting economic prospects.
- Fragile global financial system and cross-border transmission of forces.
- Capital flows to emerging markets have already dropped off, and growth is expected to slow even in the most vibrant parts of the world economy.
- Low-income countries are especially vulnerable.
Warning scenario invoked: risk of sliding into a "1930s moment" where trust and cooperation break down and countries turn inward.

Policies in the euro zone

Findings and diagnosis

Europe is at the center of global concerns because of extensive trade and financial linkages.
Progress already achieved:
- Established cross-border safety net with the European Financial Stability Facility (the EFSF) and outlined a permanent version with the European Stability Mechanism (the ESM).
- Harmonized approach to recapitalizing banks and set up a systemic risk board.
- Governance reforms to enforce stronger and more effective fiscal discipline are in train.
- European Central Bank has made long-term liquidity available to banks.
These steps are "pieces, but pieces only, of a comprehensive solution."

Three imperatives for Europe (policy recommendations)

Stronger growth
- Additional and timely monetary easing to reduce the risk that inflation "will fall well below target next year," which would raise debt burdens and hurt growth.
- Prevent banks from contracting credit; focus on raising capital levels—rather than cutting back lending—as the way to boost capital ratios.
- Maintain orderly funding conditions.
- Fiscal policy: avoid across-the-board, across-the-continent budgetary cuts that add to recessionary pressures.
- Several countries must tighten sharply and quickly, but a "large core" can pursue more gradual fiscal adjustment.
- Allow automatic stabilizers to operate.
- Those with fiscal space should reconsider the pace of adjustment planned for this year.
- Structural reforms to boost competitiveness and growth potential; fiscal sustainability depends ultimately on generating long-term growth.
Larger firewalls
- Without larger firewalls, countries like Italy and Spain "could potentially be forced into a solvency crisis by abnormal financing costs."
- Options: fold the EFSF into the ESM, increase the size of the ESM, and identify a clear and credible timetable for making it operational.
- ECB action to provide necessary liquidity support to stabilize bank funding and sovereign debt markets is essential.
- Break the vicious cycle between banks and sovereigns by restoring adequate bank capital and confidence in sovereign debt.
Deeper integration
- The crisis is a crisis of incomplete integration; monetary union needs supporting financial and fiscal integration.
- Near-term: a pan-euro area facility with capacity to take direct stakes in banks to help break bank-sovereign link.
- Longer-term: unified supervision, a single bank resolution authority with a common backstop, and a single deposit insurance fund.
- Greater fiscal integration and some form of fiscal risk-sharing to provide common support before local dislocation becomes systemic.
- Financing options for risk sharing include euro area bonds or bills or a debt redemption fund; political agreement on a joint bond would help convince markets.

Policies in the rest of the world

United States

The United States is recovering "at a timid pace" and unemployment, while declining, "remains unacceptably high."
Key priorities:
- Relieve the burden of household debt; consider programs to facilitate mortgage write-downs.
- Deal decisively with public debt: find a way past partisan impasse, including reforming entitlements and raising revenue, "without bringing down today’s economy."
- Credible measures that deliver and anchor savings in the medium term will help create space for accommodating growth today by allowing a slower pace of consolidation.

Other advanced and emerging economies

Japan: needs a credible consolidation plan to bring down public debt in the years ahead and reforms to raise long-term growth.
Countries with current account surpluses (advanced or emerging) should shift to domestic demand to support global growth; "global deficits will shrink only if surpluses shrink too."
China: continue shifting growth away from exports and investment toward consumption via measures such as fiscal support to household consumption, expanding social safety nets, and liberalizing the financial system—reforms the Chinese government has embraced.
Financial regulation: complete the reform agenda and ensure new standards are implemented consistently across countries to create a safer, more stable financial system that serves the real economy.

Role of the IMF

Functions and priorities

The IMF should lay out inter-dependencies between countries and push for a cooperative outcome.
Beyond analysis, advice, and exhortation, the IMF can provide financing when needed and act as a "commitment mechanism" to lock in good policies when funding is not needed (example: Italy’s request for IMF monitoring).

Resource needs and lending capacity

IMF estimate: a global potential financing need of $1 trillion.
IMF aim: raise up to $500 billion in additional lending resources.
Purpose: supplement resources Europe will put on the table and meet the needs of "innocent bystanders" infected by contagion, anywhere in the world.
IMF lending principles reiterated:
- Financing is for all members, euro area or otherwise.
- The IMF only lends to countries that request support and make strong policy commitments.
- Support to euro area countries must be anchored in a clear policy framework for the entire euro area.
- IMF must lend into sustainable debt positions and catalyze, not indefinitely replace, private financing.

Conclusion — key messages and calls to action

The situation is politically difficult, but the world knows what must be done and must find the political will to act.
It 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."
The longer the delay, the worse the outcome; "The only solution is to move forward together."
Germany has a central leadership role to play; its experience with Soziale Marktwirtschaft and unification demonstrates the virtues of determined solidarity.
Closing admonition (Goethe quote): "It is not enough to know, we must apply. It is not enough to will, we must do." (Es ist nicht genug, zu wissen, man muß auch anwenden; es ist nicht genug, zu wollen, man muß auch tun).

Source: "Global Challenges in 2012" By Christine Lagarde, Managing Director, International Monetary Fund, January 23, 2012.