IMF chief: Don't sacrifice growth for the sake of austerity

Balancing those sometimes competing priorities is the central puzzle facing policymakers as the world economy slows further, even in dynamic Asia, she told finance leaders at the IMF and World Bank annual meeting in Tokyo.

Ms Lagarde said she was “desperately optimistic” on prospects for a global recovery, while warning against backsliding on reforms needed to prevent future financial crises.

“The first priority, clearly, is to get beyond the crisis, and restore growth, especially to end the scourge of unemployment,” she said.

Ireland, Greece, Spain and other European countries labouring under massive debts have slashed spending and raised taxes, seeking to restore confidence in their public finances and qualify for emergency financing.

The economies of financially healthier European countries, such as Germany and Finland, face a potential blow to growth if those troubled economies fail to get their financial houses in order. At the same time, the recovery of the 17-nation eurozone could founder if tax increases and spending cuts bite too deeply.

While there seems to be a wide consensus on long-term strategies for reform, there is less agreement how painful such policies should be in the near-term given the persistent risk of recession and surging unemployment.

“One lesson though is clear from history,” Ms Lagarde said. “Reducing public debt is incredibly difficult without growth. High debt, in turn, makes it harder to get growth, so it’s a very narrow path to be taken.”

She said monetary policies must encourage banks to lend, while spending cuts are adjusted to the “right pace.” Debts must be brought down in the medium term, and structural reforms are needed to sustain growth in the long term, she said.

“That’s the package that is needed,” Ms Lagarde said. “Let us not delude ourselves. Without growth, the future of the global economy is in jeopardy.”

“It’s a marathon, not a sprint. It could take years,” Ms Lagarde said in an on-camera debate hosted by the BBC where she good naturedly traded jibes with German Finance Minister Wolfgang Schauble.

“When you are running the 42 kilometres of a marathon, you can’t just stop and turn around and go the other way,” Mr Schauble retorted, accusing those who favour going easy on debt reduction of backpedalling on their commitments.

“Increasing public debt does not enhance growth, it damages growth,” he said.

The IMF has scaled back its global growth forecast for 2012 to 3.3% from 3.5%, and has warned that even its dimmer outlook might prove too optimistic if Europe and the United States fail to resolve their crises.

“The global recovery is still too weak. Job prospects for untold millions are still too scarce, and the gap between the rich and the poor is still way too big,” Ms Lagarde said.

She has urged that European creditors give Greece an extra two years to meet austerity targets required to get and continue receiving loans, after nearly defaulting on its mountain of debt.

But such accommodations would just confuse markets, increasing uncertainty, Mr Schauble said.