Global Economy Risks Long Period of Low Growth, IMF’s Lagarde Warns

Says global economy risks getting stuck in heavy debt and high unemployment

By Ian Talley

Updated April 9, 2015 4:05 p.m. ET

Christine Lagarde, managing director of the International Monetary Fund, said policy makers are failing to take appropriate action to spur output, putting the global economy at risk of getting stuck in a long period of low growth. Photo: European Pressphoto Agency

WASHINGTON—The head of the International Monetary Fund warned Thursday that the era of low interest rates risks fueling asset bubbles around the world. At the same time, she called for more central bank easing given an even bigger risk: the prospect of a long period of weak global growth.

IMF Managing Director Christine Lagarde said the global economy risks a protracted economic slowdown as policy makers fail to take appropriate action to spur output.

“Today what we must do is avoid that [the] new mediocre becomes the ‘new reality,’” Ms. Lagarde said in a speech to the Atlantic Council ahead of next week’s semiannual meetings of the IMF and World Bank. “All policy space and levers must be utilized,” she said.

While global growth is running at roughly the average of the last three decades, Ms. Lagarde said that isn’t enough to surmount stubbornly high jobless rates, hefty debt burdens and stagnating growth in several of the world’s largest economies.

She said the IMF’s economists expect stronger growth in the U.S. and U.K. and improving prospects for the Eurozone. But their updated global economic forecast, scheduled to be released Tuesday, will downgrade the growth outlook for many major emerging-market economies including Brazil and Russia. China is also expected to slow further, but the fund said the rate of expansion is better for the economy’s longer-term prospects.

Gloomy global prospects, combined with a financial system still scarred from the 2008 crisis, aging labor forces and weakening productivity levels around the world, creates “a pretty toxic combination and we need to encourage policy makers to take the right decisions,” she said later on CNBC.

Amid the weak growth outlook, Ms. Lagarde said financial risks to the global economy were rising, particularly amid a prolonged era of low-and in some cases negative-interest rates.

“These foster a higher risk tolerance on the part of investors, which can lead to overpricing,” she said. If low interest rates persist, she said life insurers and defined benefit pension funds could soon face solvency challenges.

Strong currency movements-particularly the surge of the U.S. dollar against the euro and yen as central banks in Europe and Japan flood their economies with cheap cash-are also a threat to emerging-market economies that have borrowed in the greenback and face falling commodity revenues. Adding to their problems, borrowing costs are expected to rise and many emerging-market firms have failed to hedge their currency exposures, she said.

“These risks taken individually…could be manageable,” she said. “But we also have to contend with a structural decline in market liquidity.”

Although stronger rules and oversight have made the traditional banking sector safer since the financial crisis, risks to the system have migrated to the more opaque and less-regulated financial industry. That requires new regulations to rein in burgeoning risks, the fund says.

But the threat of prolonged low growth overshadows those risks for the IMF. That is why Ms. Lagarde says the European Central Bank and Bank of Japan should continue their easy-money policies.

Countries with room to spare in their budgets and that don’t have major debt overhangs should spend more to boost demand in the near-term, including on infrastructure, she said.

Authorities in both advanced and emerging-market nations need to overhaul their economies to spur growth potential and fuel investment to boost longer-term growth prospects and encourage investment, she said. Ms. Lagarde pointed in particular to the eurozone, Japan, China and Brazil.

And she also backed negotiations to revive declining global trade.

“There are potentially huge global gains to be had from further trade reform and integration,” she said.

To preserve the longer-term stability of the global economy, Ms. Lagarde said global powers need to strengthen the policy forums that make up the international financial architecture.

That means the U.S. needs to ratify a five-year-old deal to overhaul the IMF’s governance that would give emerging-market economies, notably China, more power at the fund in line with their growing economic heft in the world, the IMF chief said. It also means stronger collaboration with regional financial institutions, including the new Chinese-led Asian Infrastructure Investment Bank, she said.

The new bank represents the changing landscape of the global economic order, she said.

And Ms. Lagarde signaled she might back inclusion of China’s yuan in the IMF’s basket of reserve currencies.

“Strengthening the resilience of the international financial architecture would include…increasing the role of the [IMF’s lending currency] as a global reserve asset and facilitating the integration of dynamic emerging markets into the global economy,” she said.

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