US debt crisis a threat to global economy, IMF

Christine Lagarde, the Managing Director of the IMF, warns that if the US debt ceiling is not raised the consequences will be much more serious for the American and global economies than the current shutdown.

Lagarde explained that economic data coming out of the United States can have a serious impact around the world, especially on emerging economies.

She gave the example of how the emerging markets were badly affected by “taper talk” – rumors that the Federal Reserve might reduce its asset purchases (stimulus program).

However, the Fed decided last week to keep the asset purchases unchanged at $85 billion per month.

Raising the debt ceiling means increasing America’s borrowing limit. The US has a debt ceiling of $16.7 trillion. The treasury says it will run out of money on October 17th. If borrowing limit is not raised by then (the deadline), the government will effectively be broke and there will be a debt default.

The US treasury says that a debt default could trigger a financial crisis at least as bad as during the Great Recession. This announcement was followed by a plunge in New York shares today.

Lagarde warned in a news conference today:

“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 U.S. economy, but the entire global economy. So it is ‘mission-critical’ that this be resolved as soon as possible.”

President Barack Obama also warned today:

“As reckless as a government shutdown is, as many people as are being hurt by a government shutdown, an economic shutdown that results from default would be dramatically worse.

Credit markets could freeze, the value of the dollar could plummet, US interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.”

Leaders of Wall Street’s largest banks met with President Obama and members of Congress yesterday and warned that the impacts of a debt default would be magnitudes worse than the current government shutdown.

On Tuesday, the federal shutdown started after Congress could not come to an agreement on the new budget. Since then, all non-essential operations have been closed and nearly 800,000 federal employees have been furloughed (laid off) without pay. Senators and members of Congress, however, continue receiving their salaries.

Lagarde comments on advanced economies

Moving on, even when the US government reaches agreement on a new borrowing level, advanced nations must never forget the important role monetary policy plays at national and global levels.

Any remaining normalization of monetary policy in the US must be managed carefully, Lagarde cautioned, pointing out that America has a special responsibility “to 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.”

Monetary policy has bought us some time and space, which should be used wisely. Advanced economies need to move on a broad policy front, but not all with the same emphases:

  • The Euro zone needs to restore banks to health.
  • More fiscal effort is required in the US and Japan, so that debt is more sustainable.
  • A strong effort of structure is a priority in Japan and the Euro area, where jobs and growth could benefit from policies to boost supply.