International Monetary Fund Managing Director Christine Lagarde urged European policy makers to increase their bailout fund and share fiscal risks, including through a joint bond, to prevent the region’s debt turmoil from becoming a 1930s-style worldwide depression.
“We need a larger firewall,” Lagarde said in prepared remarks for a speech in Berlin today. “Without it, countries like Italy and Spain, that are fundamentally able to repay their debts, could potentially be forced into a solvency crisis by abnormal financing costs.”
Lagarde’s comments reflect concern from the rest of the world that Europe hasn’t done enough to quell a fiscal crisis now in its third year, at a time when the IMF co-finances loans to Greece, Ireland and Portugal. In their latest effort to address the turmoil, European finance ministers meet in Brussels today to discuss new budget rules, a financial firewall to protect indebted states and a Greek debt swap.
The IMF, which sees a potential financing need of $1 trillion globally in coming years, is seeking as much as $500 billion in new lending resources to play its part, Lagarde said. A day before the fund releases revised growth forecasts tomorrow that she said were lowered for most parts of the world, she called on all countries to make 2012 “a year of healing.”
Lagarde's proposals to expand the rescue fund and share fiscal risks have been rejected previously by Germany, the biggest euro economy.
The U.S. needs to reduce household and government debt, while China can “help itself and the global economy” by continuing to shift toward policies that boost consumption, Lagarde said. In Japan, “there is no way to avoid a credible” plan to reduce public debt, she said.
“What we must all understand is that this is a defining moment,” said Lagarde, a former French finance minister who took the helm of the Washington-based institution in July. “It is not about saving any one country or region. It is about saving the world from a downward economic spiral.”
Lagarde, 56, said “substantial real resources” should be added to Europe’s firepower by folding its temporary rescue fund into the new, permanent European Stability Mechanism, or ESM, whose size should be increased. A “clear and credible timetable” to make it operational is also needed, she said.
Italian 10-year note yields jumped by 229 basis points last year, or 2.29 percentage points, and the region’s shared currency fell for a second year against the U.S. dollar as investor concern increased about governments’ ability to meet their obligations.
European governments have redoubled efforts to set up the 500 billion euro ($645 billion) ESM by July, a year ahead of schedule, after a credit-rating downgrade raised concerns over the strength of the temporary aid fund created at the outset of the crisis.
A facility within the region should also have the power to take stakes directly in banks to help end a “vicious cycle” between banks and sovereigns, Lagarde told the German Council on Foreign Relations.
Policy makers should consider fiscal risk-sharing as a way to deepen the region’s integration, Lagarde said. Such a move would “would allow for common support before economic dislocation in one country develops into a costly fiscal and financial crisis for the entire euro area,” she said.
Lagarde cited “euro-area bonds or bills” and a debt-redemption fund among available options.
“Political agreement on a joint bond to underpin risk-sharing would help convince markets of the future viability of European economic and monetary union,” she said.
To stem the debt crisis in the 17-nation euro region, Lagarde also called on the European Central Bank to make “additional and timely monetary easing” as inflation and growth slow. She said its actions to provide “the necessary liquidity support to stabilize bank funding and sovereign debt markets” would be “essential.”
The Frankfurt-based ECB has bought 217 billion euros of bonds from distressed member countries since May 2010 and last month issued 489 billion euros in unlimited three-year loans to euro-region banks.
The World Bank last week predicted the euro-area’s economy would contract 0.3 percent this year.
“Although the economic outlook remains deeply worrisome, there is a way out,” Lagarde said. “Now the world must find the political will to do what it knows must be done.”
Not all European countries need to quickly tighten public finances, Lagarde said, mentioning a “large core” where reducing the deficit can be more gradual.
“Those with fiscal space should support the common effort by reconsidering the pace of adjustment planned for this year,” she said, just as European governments negotiating a new fiscal treaty are hewing to an agenda championed by German Chancellor Angela Merkel that puts stiffer rules on deficit control.
-- Editors: Brendan Murray, Patrick Harrington