Lagarde Cautions Davos on Global Deflation Risk
When Christine Lagarde arrived in Davos in 2008 as French finance minister, the battle was just beginning against a financial crisis that would bring the world economy to its knees.
Six years later, as head of the International Monetary Fund, she warned the World Economic Forum at the Swiss mountain resort that the fight isn’t over, just before a currency crisis 7,000 miles away in Argentina reinforced her view. She urged policy makers to remain alert for asset bubbles and prevent a looming threat to prosperity: deflation.
Lagarde’s concern springs from her experience as an eyewitness to the spread of the U.S. mortgage meltdown to banks including France’s BNP Paribas SA and an understanding of how freely money traverses borders. As officials from the U.S. and Europe exuded optimism in Davos last week, Lagarde cautioned that progress is unbalanced, with still “massive unemployment” worldwide even as some markets look “hot.”
“In case there was a shock, which is something we have to consider and imagine -- not that it is in the cards yet -- then we have the risk of deflation,” Lagarde said Jan. 23 at a forum in Davos. “What the crisis has taught us is that we need to be extremely vigilant and expect bubbles from places that we don’t anticipate.”
The IMF managing director since July 2011, the former labor lawyer and first woman to lead the institution has been contending with a fiscal crisis across Europe and helped oversee emergency loans to Greece, Portugal, Ireland and Cyprus.
Less than two months into the job, Lagarde called on European officials to urgently recapitalize their banks or face a liquidity crisis. The German and Spanish governments rejected the idea the next day, saying enough had been done already.
“When you’re the head of the IMF, your role is to be the one who cries wolf,” Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington, said in an interview. As French finance minister, “in a forum like Davos in that role, she’s by and large a saleswoman,” he said.
Lagarde, 58, is effective because she has a “rock-star media appeal” that helps amplify the IMF’s warnings on the global economy, Kirkegaard said.
Her celebrity was on display in Davos. The line to see her started forming 45 minutes before her session. When told by aides that the people were there to see her, she expressed surprise.
“She is a role model,” said Lise Kingo, an executive vice president at Danish drugmaker Novo Nordisk A/S who attended Lagarde’s session. “She is pretty rare in the sense she has an operational, economic framework, but she puts her perspective in a historic, cultural context.”
At the National Press Club in Washington on Jan. 15, Lagarde spoke of deflation as the “ogre that must be fought decisively.”
“The crisis still lingers, yet optimism is in the air,” she said. “The big priority for policy makers in 2014 is to fortify the feeble global recovery and make it sustainable.”
Less than a week later, when the IMF raised its 2014 outlook for world economic growth for the first time during Lagarde’s tenure, it did so only slightly: to 3.7 percent, compared with an October estimate of 3.6 percent.
Emerging markets are vulnerable to spillover effects as developed countries start to rein in monetary stimulus, Lagarde said last week in Davos.
The next day, emerging-market stocks dropped, extending the worst start to a year since 2009, as currencies tumbled on concern that a slowdown in China and Federal Reserve stimulus tapering will trigger more outflows. Argentina scrapped some of its currency controls a day after devaluing the peso as policy makers there sought to stem a financial crisis and restore investor confidence.
Among the new risks to advanced economies, the IMF’s forecast report cited “very low inflation,” particularly in the euro area, as becoming more significant and raising the prospect that longer-term inflation expectations could head lower.
Euro-area inflation was at 0.8 percent in December and has been below the European Central Bank’s 2 percent ceiling for 11 months. While it’s forecast to continue to undershoot the target through next year, ECB President Mario Draghi said in an interview with German magazine Der Spiegel released on Dec. 28 that “at the moment there’s no immediate need to act.”
In the U.S., the Fed announced plans last month to reduce monthly bond purchases to $75 billion from $85 billion, citing improvement in the labor market. The jobless rate in December fell to 6.7 percent, a five-year low.
“We this year have tailwinds with kind of good fundamental economic core growth in a broad range of areas,” U.S. Treasury Secretary Jacob J. Lew said in an interview in Davos on Jan. 23.
International investors are the most upbeat about the global economy than at any time in almost five years, buoyed by the U.S.-led revival of industrial nations, according to the Bloomberg Global Poll. Fifty-nine percent of Bloomberg subscribers surveyed last week said the economic outlook is improving. That’s up from 33 percent in November and marks the most optimistic result since the poll began in July 2009.
Olli Rehn, the European Union’s economic and monetary affairs commissioner, said last week that “green shoots are clearly visible” in Europe.
In Davos, Lagarde was less upbeat.
Continued low inflation, she said, could have “a consequence in terms of the cost of debt and the burden of debt” for both countries and companies.
Lagarde is trying to “shape the IMF as an intellectual, caring organization” and steer its narrative away from the specifics of the euro-area crisis, said Domenico Lombardi, a former IMF board official who is now the director of the global economy program at the Waterloo, Ontario-based Centre for International Governance Innovation.
With some 200 million people out of work globally, inequality is one of the broad themes Lagarde is emphasizing.
The income gap between rich and poor “has widened in all corners,” she said. “The more unequal the society is and the more variance there is between the haves and the have-nots, the less sustainable growth will be.”
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