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Richard Moore

IMF head in shock fiscal warning

By Chris Giles and Gillian Tett in Davos

28/01/08 "Financial Times  " -- - The intensifying credit crunch is so severe 
that lower interest rates alone will not be enough ³to get out of the turmoil we
are in², Dominique Strauss-Kahn, the managing director of the International 
Monetary Fund, warned at the weekend.

In a dramatic volte face for an international body that as recently as the 
autumn called for ³continued fiscal consolidation² in the US, Dominique 
Strauss-Kahn, the new IMF head, gave a green light for the proposed US fiscal 
stimulus package and called for other countries to follow suit. ³I don¹t think 
we would get rid of the crisis with just monetary tools,² he said, adding ³a new
fiscal policy is probably today an accurate way to answer the crisis².

Mr Strauss-Kahn¹s words rip apart a long-standing global consensus that fiscal 
retrenchment in the US and Japan is needed to help reduce huge trade imbalances.

It comes as the IMF is due to release new economic forecasts this week which, he
said, would show a ³serious slowdown and it needs a serious response².

The US Federal Reserve starts a regular meeting tomorrow and markets expect 
another half-point cut on top of the 0.75 percentage-point cut last week.

Mr Strauss-Kahn¹s dramatic change in stance amazed Larry Summers, the former US 
Treasury secretary. He is known for saying that the IMF stands for ³It¹s Mostly 
Fiscal² because the organisation has to be tough with countries¹ budgetary 

But such is his concern about economic prospects if the US slows and other 
countries do not pick up the slack in world demand that he supported Mr 
Strauss-Kahn. ³This is the first time in 25 years that the IMF managing director
has called for an increase in fiscal deficits and I regard this as a recognition
of the gravity of the situation that we face,² said Mr Summers.

The dark economic mood in Davos was reinforced at the weekend by John Thain, the
new chief executive of Merrill Lynch, who predicted the problems in subprime 
mortgage markets would spread to credit card and consumer loans. ³It will be a 
while before you see a return to normality in the banking system,² he said.

Thomas Russo, vice-chairman of Lehman Brothers, said: ³Absent government 
intervention, the economic picture is very grey but with government intervention
you have a decent chance of stabilising the picture.²

The IMF¹s call for countries with strong fiscal positions to loosen their 
budgets gained approval from Christine Lagarde, the French finance minister, and
Palaniappan Chidambaram, the Indian finance minister.

Ms Lagarde suggested Germany would be a prime candidate for fiscal loosening, 
while Mr Chidambaram said: ³India may have some room, if necessary, for some 
fiscal stimulus.²

But in a rare direct reference to China, he called on Beijing to play its part. 
³China has huge headroom to stimulate domestic consumption.²

However, it is the global community¹s lack of confidence that China will play 
ball in offsetting a slowing US consumer that makes greater fiscal laxity in 
many countries appear suddenly appealing.

But amid a sudden enthusiasm for fiscal stimulus packages, some voiced caution. 
Professor Ken Rogoff of Harvard University and a former chief economist of the 
IMF said aggressive fiscal easing generates ³more harm than good in most cases²,
leading to unsustainable budgetary position that require painful correction in 
the longer term.

Copyright The Financial Times Limited 2008
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