Is austerity the only path to recovery?

Photo Christine Lagarde / Managing Director, IMF / April 4th, 2012



Europe’s economic crisis continues, and the way it plays out will decide the future course of the world economy. Among those who are trying to steer the continent, and especially the euro zone, away from the edge of the precipice is Christine Lagarde, managing director of the International Monetary Fund. She has recommended policies such as deeper economic integration and higher firewalls to turn Europe around. Lagarde also has the delicate task of restructuring the IMF so that fast-growing emerging economies have a voice in the institution that is commensurate with their increasing economic clout, without alienating other member countries.

Knowledge@Wharton and ParisTech Review – We learned in the last week that Italy and Ireland are both returning to recession. Do you see any fallout from that? Is it a sign that the world outlook, which was improving, is getting shaky again?

Christine Lagarde – As part of this fragile recovery that we have been seeing since January, we have always considered that Europe and the euro zone in particular would go through a mild recession. The countries that are driving the recession at the moment are clearly countries like Ireland, Greece, Portugal and Italy. So this doesn’t come as a surprise. It’s part of a process that we had anticipated and were forecasting for 2012.

Related to that, austerity has been one of the chief policy levers Europe has been using to deal with the crisis. Do you think European leaders have focused on austerity too much and gone too far with it? Should a better balance be struck between austerity and stimulus?

If everybody goes at the same pace with austerity measures, it puts the whole region at risk. What we have advocated consistently now for at least the last six months is that there should be a proper balance within the zone, particularly within the advanced economies. We also need a proper balance between the austerity measures that are necessary and the growth-facilitating measures. So, obviously, it’s not a one-size-fits-all.

Some countries can afford to relax a little bit the austerity policy that they had embarked on. Others cannot relax the austerity measures. For instance, Greece is one country that certainly should not relax its measures. Italy is another one.

You’re giving a little latitude to Spain.

I’m not really thinking in terms of latitude. Some countries have to be very, very brutal, in terms of reducing their deficit and bringing sanity to their public finances. The periphery of the core of the euro zone is clearly at stake in that regard. Then you have countries that are pretty much balanced and where you can just let the automatic stabilizers play out. They can let increased expenditures in the welfare system come into play and not compensate [for] the reduced revenues that result from their economic situation. Still other countries – not many, unfortunately – can slow the pace, relax, and let the recovery pick up. A couple of large European countries could probably look at that approach.

Are you saying that you’re in agreement with the way that balances at the moment?

In terms of diagnosis, I agree that austerity should not be the exclusive focus of attention. It should not be the underlying general theme across the region in terms of economic policy. I also agree that growth is a key factor to try to not only kickstart, but maintain the recovery that is beginning to take hold in some countries. Otherwise, it makes the whole exercise extremely difficult.

Can you have too much austerity in the short term rather than it being spread out more evenly towards the medium and long term?

It depends on the situation. There are some countries in which sharp adjustment is needed in order to be able to bounce back from that situation.

You have said that Europe needs deeper integration and bigger firewalls.

I said that when nobody was yet at the table. And now…

They’re there.


The question is, what does deeper integration look like? What would be some medium- and long-term goals for integration?

Deep integration is a recent development. It was much needed in order to consolidate the currency zone. We’ve seen things recently that were totally unexpected and almost unimaginable only 18 months ago. What is important for better integration is a combination of solid fiscal coordination with real discipline imposed upon the partners, including sanctions that are not only applicable, but are also applied if the rules are violated.

Would that give the GDP ratios that need to be met in terms of deficits and overall debts?

Yes. They have added to what was already planned in the growth and stability pact but at that stage with very little by way of teeth and measures to make sure that it was implemented. What they’ve added as well is a preventive aspect to the pact, where they anticipate and can actually be helpful to members that are going down a trend that is going to lead them to violate the rules, [such as] the 3% deficit and the 60% debt-to-GDP ratio. So that’s a good thing.

In terms of better integration, one institution has played a much better and very significant role lately – the European Central Bank. Number one, it has reduced the level of collateral to make sure that it’s of better service to the members. And number two, the ECB has provided much more liquidity to the banks, so that they can not only finance themselves, but also provide credit to the markets and avoid the negative deleveraging that nobody wants.

The ultimate integration that would be desirable would be to have some sort of joint liability. That could come from something like euro bonds or a joint instrument that would pool the countries together in terms of their borrowing. Now, they’re not there yet. I think some of the member states will have to improve their situation and their competitiveness. They will have to catch up with the delays they suffered from, that they inflicted upon themselves, by doing the wrong thing or simply by not doing anything. Once that has happened, then one might hope that this sort of fiscal integration and joint liability would be in place.

There has been a lot of resistance to that.

Yes, absolutely.

The idea of Euro bonds raises hackles in a lot of quarters. But your point is that if the euro zone members can cooperate on these measures, that would help.

Even on that front, there has been huge progress. If you look back 18 months ago, to the time when Luxembourg Prime Minister Jean-Claude Juncker and Italian finance minister Giulio Tremonti proposed issuing Euro bonds in a joint paper in the Financial Times, at that time German Chancellor Angela Merkel was absolutely dead set against it. Now her position has evolved. She – or her minister of finance – is saying, “Well, not now, but in the future, why not?” And the five wise economists of Germany have themselves put together a proposal that could go a long way toward bringing some joint responsibility among the members.

That’s a big shift.

Yes, it’s a huge shift.

Is there a role for the IMF in helping increased integration move forward? Or is this something the Europeans do on their own?

It has to belong to them. It has to be theirs. They should have ownership of all of that. All we can do is identify, demonstrate with the team of great experts, that we have in this institution, the benefits of doing so and the drawbacks of not doing it.

And perhaps contributing to the stability fund that might allow integration to go more smoothly?

Well, we will be part of the firewall at some stage. And the firewall is not just going to be about Europe. They are all going to have to build their firewall, and I hope that we will be seeing developments very shortly.

The IMF is a multilateral institution. We’ll have to develop more firepower in order to be able to assist not only the euro zone but also any country outside the euro zone that could be a collateral victim of any resurgence of the crisis.

Is it possible in the medium and long term for the euro zone to keep the common currency without more political integration?

It’s difficult to read into the future. But what we can say is that it would certainly strengthen and make the currency zone much more sustainable and safe. I don’t know whether to call it political integration, but certainly we need much deeper economic and fiscal integration.

In Spain, youth unemployment is about 50%. You’ve spoken about this, and it’s very important to you. Are there any specific policies that can help to redress this situation, apart from those that would stimulate the economy in general and help it recover?

We all wish there were some magician’s wand we could wave to create jobs. At the end of the day, that is what everybody wants to do. It’s not just about growth in and of itself … it’s about jobs. It’s about keeping people off the street. It’s making sure that they have a chance to express themselves on the job market and have dignity through work. But apart from stimulating growth, apart from an economic situation that warrants the creation of jobs, there is no magical recipe for that. But it’s a key issue.

We keep talking about growth. We have seen, in the past, occasions where growth was actually generated but without jobs. It was growth exclusively directed at a very small, elite portion of society. When you think of a country like Spain, and many other countries as well, it has to be growth that actually creates jobs. It should be growth that is sufficiently inclusive that it actually helps keep the chemistry of society together.

It can’t just be growth in one sector, such as the finance sector, for example.

Absolutely. Yes.

How do you see the role of the IMF evolving in dealing with global economic issues during the next few years?

My constant concern and ambition is to make sure that the IMF continues to be relevant to its membership. For the IMF to be relevant, it has to be representative of the membership and therefore credible from an institutional point of view, and it has to be relevant from a quality point of view. We need to both represent our membership, and we need to provide the quality of advice, the quality of service, the quality of technical assistance, the quality of surveillance, that will make us constantly relevant. It’s a combination of quality and credibility that will continue to make us relevant.

The role of the IMF is evolving, and we have to be sufficiently agile so that we actually pick up the lessons from the crisis. If I could give an example, the traditional exercise of the IMF was to conduct what we call the Article Four consultation. These were bilateral exercises that consisted of going under the skin of a country and finding out whether the economic policies were the right mix and whether we could recommend better solutions and options. Now, on the occasion of the financial crisis, we went much further into multilateral surveillance and into studying the spillover effects. The financial crisis may have hit a particular country, but it also affects many other countries. How did that contagion occur? How fast did it contaminate the rest? Why was it so fast through those particular segments?

These are questions on which the IMF can offer added value compared with others because we have this huge database of knowledge and information about 187 members of the institution. We are in this sort of surveillance position, which is very privileged, because we have access. We can analyze, and then we can show to the members what will be helpful for them. So, our role has evolved to include much more of an effective, more holistic surveillance of the economic situation.

And I think we need more money [laughs].

How can the IMF build more credibility and quality?

Credibility is a matter of being representative of the institution, and that is a factor of our quota allocation, a factor of our governance. Does the executive board actually reflect the membership? We have to represent our membership and we have to look like our membership. That calls for diversity of the staff in terms of gender, geographical origin, ways of thinking and cultural background. That can help build credibility.

Quality is not a subset, but it’s closely linked to the issue of diversity. [The IMF must] have the ability to bring together people with different backgrounds, from different regions of the world to confront issues. I think that’s a big test of the relevance of the institution.

Historically the IMF has been dominated by the industrialized Western countries. How do you see the role of the BRIC nations, especially China and India, in the IMF?

Their role is significantly evolving. It reflects, as I was telling you for the credibility issue, the economic evolution of those countries. It is best manifested in three areas. One is the staff. How many staff do we have in the institution who come from India or from China? This applies throughout the institution but also at the top level. How many people in the management originate from China or India? We have quite a number of them. I’ve just recently appointed the Secretary of the Board, who is a Chinese national. One of my deputy managing directors is a Chinese national. Among the key leaders of this institution, we have many very talented Indian economists who lead key departments like the strategic department. So, that’s one level.

Then you have a second level, which is quota and voice. That is an evolving phenomenon, because we are right in the middle of the quota reform, which is going to shift 6% of current quota to dynamic emerging market and developing countries, while protecting the quota shares and voting power of the poorest members. Clearly, the BRICs will be among the recipients of these additional quotas, and as a result of the reform, all of them will be within the top 10 countries of this institution in terms of quotas.

The third level, which I don’t think is as relevant but it matters, is whether they sit at the board of the institution. As it happens, they do. Brazil sits at the table, Russia sits at the table, India sits at the table. China does as well.

What role could the IMF play in bringing about a better balance between rates of exchange, for example, for a possible re-valuation of the yuan versus the U.S. dollar and the euro?

It’s funny that you would focus exclusively on these currencies, because our job is to assess the appropriate exchange rate – and to actually say what we think of it – for all 187 members of the institution. We do that through appropriate modeling, gathering of data and comparing and taking into account multiple data, including the current account. It’s a daunting task because we don’t make anybody happy. Everybody sees himself either higher or lower and our assessment is not necessarily always welcome or well-received. But we do it on the basis of what we know, what we observe, what we can compile and model. We are in the process of refining and updating our methodology. Probably later in 2012, we’ll be able to come up with a new methodology and model of assessing exchange rates.

I’m wondering if the IMF will be raising its projected growth for the U.S. at the spring meeting. Right now I think it’s projected 1.8% growth.

Maybe a little bit, but you’ll have to be patient, because the meeting is not until three weeks from now. But maybe a little bit. There have been good signs, let’s face it. There have been good numbers coming out, particularly on the unemployment front and on some high-frequency indicators as well. There are measures taken at the moment, particularly on the housing markets, that might turn out some significantly improved results.

Of all the things that you do here, what are you most passionate about? What would you really like to make sure happens? It could be a small thing, it could be a large thing. What is it that really has your heart?

That’s complicated. I think it’s this issue of relevance … that is of real concern to me. You see, this is a very fascinating institution because it’s completely counter-cyclical. When the world around the IMF goes downhill, we thrive. We become extremely active because we lend money, we earn interest and charges and all the rest of it, and the institution does well. When the world goes well and we’ve had years of growth, as was the case back in 2006 and 2007, the IMF doesn’t do so well both financially and otherwise.

For this institution, which is a fascinating mix of almost all countries of the world with a single objective that should transcend all their respective individual policies and strategies, for it to be sustainable, we need to be very agile, very in touch with our membership, with our client base, if you will. We need to be able to invent and reinvent ourselves in many ways. So, as I was explaining about going from bilateral to multilateral surveillance, from a narrow focus to something that is more holistic, that is exactly what is at stake.

This interview has been realized in Washington, DC, in partnership with Knowledge@Wharton, whom we wish to thank for taking the biggest load of the work. It was first published by Knowledge@Wharton on April 3d 2012 under the title Emerging Market Nations Will Get More Power in the IMF.


  • IMF website
  • E-bonds would end the crisis (Jean-Claude Juncker and Giulio Tremonti, Financial Times, 5 dec. 2010)
  • Christine Lagarde in Davos, 2012 (video)

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