Sunday, September 04, 2011

Europe’s Necessary Steps Towards Economic Recovery

FT: Lagarde Capital Call Surprises Regulators
FT: Lagarde’s Ugly Truth on Debt
IMF: “Global Risks Are Rising, But There Is a Path to Recovery”: Remarks by Christine Lagarde at Jackson Hole
WSJ: Central Bankers Worry Economy Still in Peril

Last week, the Managing Director of the International Monetary Fund (IMF), Christine Lagarde, called on European governments to take action to remove the cloud of uncertainty hovering over the region’s governments and financial institutions as it struggles to recover from the global financial crisis. In an effort to promote strong, sustainable, and balanced growth, Ms. Lagarde proposed a three-step plan she believes will restore confidence in the European Union and put it on the road to recovery.

According to Lagarde, the first step is to lower government debts to sustainable levels. Containing growing costs for government programs, such as pensions and healthcare, is key to ensuring that governments will not have to continue adding to their debt to pay for such programs. Reducing spending on programs that already exist also helps free up money that governments can use in the short-run to support jobs and growth. Lagarde insisted, however, that cutting spending alone will not be enough to stabilize government debt in the region. European countries must also find a way to raise more money. She encouraged the European Central Bank (ECB) and Eurozone countries to continue their financial support of the countries in crisis.

The second step to sustainable growth is to strengthen Europe’s financial institutions. To do so, banks need to raise more capital (i.e., cash), which will enable them to increase lending to spur economic activity and survive any further losses they may incur. According to Lagarde, banks should seek capital from private sources first, and only seek public funding if absolutely necessary. If the use of public funds is unavoidable, Largarde suggested that the European Financial Stability Fund or another European-wide funding mechanism could make direct capital injections into the region’s weakest banks.

The last step of Lagarde’s vision for Europe’s economic recovery is to develop a common vision for the European Union’s future. The current crisis has exposed serious flaws in the architecture of the European Union that threaten the entire integration project. Therefore, it is important for European leaders to agree on how to prevent and address economic downturns in the future. Failure to do so could expose the EU to a repeat of the problems it is currently facing.

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