International Monetary Fund Managing Director Christine Lagarde said it’s “mission-critical” for the U.S. to raise its $16.7 trillion debt ceiling, warning policy makers that failure to do so would seriously hurt the country and the world.
The first face-to-face talks between President Barack Obama and congressional leaders failed to break the budget logjam as a partial U.S. government shutdown entered its third day, raising the prospect of a prolonged standoff extending to the borrowing limit.
“The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the U.S. economy, but the entire global economy,” Lagarde said in a speech in Washington to students at George Washington University. “So it is ‘mission-critical’ that this be resolved as soon as possible.”
Lagarde’s concern echoes a report by the U.S. Treasury Department today that a government default could have catastrophic consequences that might last decades. Treasury Secretary Jacob J. Lew has said the U.S. started using final extraordinary measures that will be exhausted no later than Oct. 17 to avoid a breach of the debt limit.
Less than a week before releasing new global growth forecasts, Lagarde said the fund sees the expansion as subdued, even as signs of growth appear in advanced economies.
Japan’s stimulus policy seems to be working, she said, and the U.S. housing sector is improving.
The tapering of U.S. monetary stimulus, which the Federal Reserve refrained from starting last month, needs to be carefully managed, she said.
“Because the normalization of monetary policy affects so many markets and people across the globe, the U.S. has a special responsibility,” she said. The Fed should “implement it in an orderly way, linking it to the pace of recovery and employment; to communicate clearly; and to conduct a dialogue with others.”
While the Fed should start tapering $85 billion in monthly bond purchases if the economy improves, the era of higher borrowing rates “is way down the road,” she said in response to a student’s question.
Bond prices slumped internationally and emerging-market stocks plunged after May 22, when Fed Chairman Ben S. Bernanke said for the first time the Fed could withdraw stimulus “in the next few meetings” so long as the economic outlook showed “sustainable” improvement.
While the September decision not to start withdrawing stimulus gave developing economies some relief, the market turmoil since May has the potential to dent growth in major emerging markets, Lagarde said.
Responses to capital outflows should vary according to countries, she said. Currencies should be allowed to depreciate, while looser monetary policy is more problematic in nations such as Brazil, India or Indonesia that are facing inflationary pressures, she said.
“Likewise, there is not much space left across many emerging markets for using fiscal policy, given high debt and deficits,” she said, recommending “infrastructure investment in places like India and Brazil, deepening financial markets, and opening up trade regimes” instead.
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