WASHINGTON – The head of the International Monetary Fund on Monday urged indebted countries in Europe and elsewhere to reduce their budget deficits only gradually to avoid further damaging their economies.
Christine Lagarde said in a speech in Zurich that steep cuts tend to slow an economy, particularly if a nation is already suffering from weak growth.
The head of the global lending organization didn’t refer to any specific countries. Still, her speech came one day after voters in France and Greece rejected governments associated with cuts in social spending and other austerity steps.
Some European nations, such as Greece, have agreed to specific deficit targets as part of an international bailout partially funded by the IMF. Lagarde’s remarks don’t affect those agreements.
The appropriate path is country-specific, she said.
“Some countries under severe market pressure have no choice but to move faster,” she said. “On the whole, however, adjustment should be gradual and steady.”
Many European countries have been trying to reduce their debt loads as a percentage of their economies. When they have taken steps to cut deficits, such as raising taxes or cutting spending, their economies have shrunk. That makes it harder to reduce deficits as a percentage of their economy.
Lagarde urged governments to avoid that trap. Instead, they should focus on gradually reducing debt levels and not cutting further if the economy weakens.
“There is no avoiding this brake of fiscal adjustment,” she said in a prepared version of her remarks. “But if calibrated correctly, we can make sure it doesn’t do too much harm to growth.”
Spain, for example, seeks to cut its government budget deficit from 8.5 per cent of economic output to 5.3 per cent this year and below the European Union’s goal of 3 per cent by 2013. But many investors worry that it won’t be able to do so with its economy in recession and unemployment at 24 per cent.
The IMF last month forecast that the world economy would grow a modest 3.5 per cent this year. It said the U.S. economy will likely expand 2.1 per cent. And the 17-nation euro zone is expected to slip into recession.
Europe’s economic struggles come as governments throughout the region are struggling to impose cuts.
“Austerity versus growth is very much the debate of the hour,” Lagarde said. “I believe it is a false debate. … We can design a strategy that is … good for stability and good for growth.”