Global deflation is rising risk, says IMF’s Christine Lagarde

Even though things look promising for the world economy, global inflation is a rising risk, IMF Managing Director Christine Lagarde warned in Washington D.C. today.

With inflation in the advanced economies running below the targets of most central banks, “there are rising risks of deflation,” she said.

Lagarde added “If inflation is the genie, then deflation is the ogre that must be fought decisively.

With optimism in the air it is important we all stay focused on policies required for sustainable growth and rewarding jobs. The global economy has avoided a worst case scenario thanks to policymakers’ efforts over the last five years, Lagarde said at the National Press Club.

During the second half of 2013, worldwide growth momentum had gathered pace, and should build a further head of steam this year, driven mainly by improvements in the advanced economies.

Lagarde stated:

“Overall, the direction is positive, but global growth is still too low, too fragile, and too uneven. It is not enough to create the jobs for the more than 200 million people around the world who need them.”

However, the benefits of growth are only being enjoyed by a minority of people in far too many countries, she pointed out.

2014 a milestone year

This will be a milestone year with the 100th anniversary of the beginning of WWI (First World War), the seventieth anniversary of the Bretton Woods conference where the IMF was born, and the twenty-fifth anniversary of the fall of the Berlin Wall.

Lagarde noted:

“It will also mark the seventh anniversary of the financial market jitters that quickly turned into the greatest global economic calamity since the Great Depression. Optimism is in the air: the deep freeze is behind, and the horizon is brighter.”

“My great hope is that 2014 will prove momentous in another way – the year in which the ‘seven weak years’, economically speaking, slide into ‘seven strong years.’ ”

However, she emphasized that to really put the crisis completely behind us, we still need a sustained and considerable policy effort, coordination and the right mix of policies.

Global deflation, a real and rising threat

For the most advanced economies, the prognosis is subject to considerable risks. Inflation in nearly all the developed nations is running below central bank targets. Deflation could be the kiss of death for the current recovery.

The global economy was kept afloat during the Great Recession thanks to the emerging markets. Together with the developing nations they made up approximately 75% of global growth over the last five years.

However, an increasing number of emerging markets are growing at a much slower rate now as the economic cycle turns. There are also risks arising from the volatility of capital flows and financial market turbulence.

Strengthen the global recovery

Global growth is still very modest, well below its potential 4% per annum rate, Lagarde explained. “This means that the world could create a lot more jobs before we would need to worry about the global inflation genie coming out of its bottle.”

There is one imperative all the economies worldwide must adhere to – the need to remain focused on the policies for rewarding jobs and sustainable growth. “The big priority for policymakers in 2014 is to fortify the feeble global recovery and make it sustainable.”

Central banks, especially in the advanced economies, should return to more conventional monetary policies only when it is compellingly clear that robust growth is firmly rooted. The unconventional monetary policies in use at the moment have given nations elbow room to place the reforms required to jump-start growth and jobs.

Lagarde comments on different regions of the world

The United States – growth is definitely speeding up, driven mainly by consumer demand and “helped by the loosening of the fiscal corset in the recent budget deal.” Even so, it is vital that premature withdrawal of monetary support is avoided. Lagarde also emphasized the importance of returning to an orderly budget process.

The Eurozone – is finally turning the corner from a lengthy recession to economic recovery. However, growth is still very lopsided while unemployment, especially in the peripheral countries, is still far too high. “Governments should accelerate reforms to boost labor market participation and enhance competitiveness.”

Japan – its challenge is to agree to medium-term fiscal changes and economic and social reforms required for healthier and sustainable growth.

The emerging markets – any signs of financial excess should sound loud alarms bells, Lagarde warns policymakers. Especially in the form of rising debt and asset bubbles. Financial regulation should be strengthened and implemented so that credit cycles may be better managed. In order to unlock their growth potential many nations need further structural reforms.

Low-income nations – strong defenses should be built to protect against either direct or consequential external shocks. Governments need to introduce and implement laws to raise more revenue. “They should also keep spending selectively on important social programs and infrastructure projects.”

Lagarde said:

“We have certainly played our part in the collective response to the crisis—making 154 new lending commitments and providing technical assistance to 90 percent of IMF members since the onset of the crisis in 2008, and providing the best possible policy advice.”

“One of our strengths is that we have to look at the bigger picture – how all the moving parts fit together, how what happens in one country affects the wider global economy.”

According to the World Bank, the global economy is bouncing back, five years after the financial crisis struck. However, it warns that the US Federal Reserve’s scaling back on the stimulus program plus some structural changes in the Chinese economy have the potential to undermine the recovery.