IMF Warns that US Failure to Act on Debt Jeopardises World Economy

International Monetary Fund (IMF)managing director Christine Lagarde said that raising the US’s US$16.7 trillion debt ceiling as soon as possible is “mission-critical”.

“The government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the US economy, but the entire global economy,” Lagarde said in prepared remarks to students at George Washington University.  She added that growth in the US has already been undermined by too much fiscal consolidation, and will be below 2% this year before rising by about 1 percentage point in 2014.

In the speech, which comes ahead of IMF and World Bank annual meetings next week, Lagarde also said that the tapering of US monetary stimulus, which the Federal Reserve held back from initiating last month, needs to be carefully managed.

“Because the normalisation of monetary policy affects so many markets and people across the globe, the US has a special responsibility,” she said. The Fed should “implement it in an orderly way, linking it to the pace of recovery and employment; to communicate clearly; and to conduct a dialogue with others.”

Lagarde’s concerns were echoed in a report by the US Treasury Department today saying that any default by the US on its debt “has the potential to be catastrophic.” Treasury secretary Jacob Lew has said the US started using final extraordinary measures that will be exhausted by 17 October to avoid a breach of the debt limit.

Lagarde also said that the IMF sees expansion as subdued globally, despite recent signs of renewed growth in developed economies. Although progress in the euro zone and Japan was encouraging, the transition to more stable growth could take time.

Her speech also included an appeal to governments to better work together on reforming the financial sector, where progress had been too slow, partly due to divergences among different countries. She singled out the ‘danger zone’ of shadow banking, or the nonbanking sector that is not under formal regulation.

In the US, shadow banking is twice the size of the banking sector, and in China half the credit given this year has come from shadow banking, Lagarde said.

“Putting this all together in a globalized world is a headache,” she said about financial regulation. “And yet, it must be done – nothing less than global financial stability depends on it.”


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