BRUSSELS — The International Monetary Fund, known throughout its history for urging governments to slash their budgets, is now worried that a global round of austerity may trigger a new recession and is urging countries to look for ways to boost growth.
On Monday, the agency warned the world’s leading economies that belt-tightening by governments, companies and consumers has been become so aggressive that the global economy could falter because of anemic demand.
“The immediate risk is that the global economy tips into a downward spiral. . . . Even in a less severe scenario, key advanced economies could suffer from a protracted period of low growth,” the IMF said. The agency report urged all but the most debt-strapped nations to boost growth through expansive government budget and spending policies or through central bank measures such as lowering interest rates to stimulate the economy.
This advice comes as European leaders are preparing their newest strategy for addressing the debt crisis roiling markets in Europe and beyond. Top European officials are trying to put together a plan before they hold a crucial meeting Sunday, seeking to show they can shore up the continent’s banking system and stem the crisis before any major government defaults.
While leaders have agreed on the broad outlines of what should be done, German officials on Monday played down the likelihood of a grand and quick fix.
“Dreams that are again coming back, that . . . everything will be solved and everything will be over, will again not be fulfilled,” German Chancellor Angela Merkel’s chief spokesman, Steffen Seibert, told a news conference. German Finance Minister Wolfgang Schaeuble said he did not expect the European summit to reach a “definitive solution,” according to news agency reports from Duesseldorf.
The IMF’s tight-budget orthodoxy was set aside three years ago, when the financial crisis prompted the agency to call for massive public spending to maintain economic activity. But the fund quickly returned to admonitions about the “wall of debt” rising in developed countries, including the United States.
Now, the IMF is shifting gears again.
The new tone is especially striking because it comes at a time when world leaders are focused on Europe’s debt crisis, in particular the risk that Greece and several other European countries could default on huge debts run up over years of profligate spending.
“We call it a sovereign debt problem, but if countries were growing and were competitive we would not be in the position we are in today,” Antonio Borges, director of the IMF’s European division, said at a recent conference in Brussels. Stronger economic growth in struggling countries, for instance, could help them raise the revenue needed to pay their bills.
At the IMF’s annual meetings last month, and again in its report Monday, fund officials praised governments that found ways to strike a balance between supporting growth and jobs in the short run and reducing budget deficits in the medium term.
The IMF singled out President Obama’s $447 billion proposal to lift the economy and create jobs through a combination of tax breaks and new public spending. While the cost could add to the huge national debt, agency officials said the U.S. government should put an immediate priority on fighting unemployment, even if this means slowing the rate at which federal deficits are reduced. Obama’s plan, however, has poor prospects on Capitol Hill.
European governments, meanwhile, were urged to pump hundreds of billions of dollars into the continent’s banking system, even if this meant adding to public debt. Nations such as Germany that have strong economies or healthy credit ratings were encouraged to slow any efforts to cut their budget deficits and instead do what they could to boost growth. China, which has $3 trillion in foreign reserves, was urged to buy more goods from other countries.
The IMF called on nations with exorbitant levels of debt, such as Greece and Italy, to speed reforms aimed at making their economies more competitive and capable of stronger growth.
In general, the IMF wrote in a recently released review of the European economy, “the pursuit of nominal deficit targets should not come at the expense of risking a widespread contraction in economic activity.”
Some critics suggest the world economy is still suffering from IMF-inflicted wounds, saying the organization prematurely began an austerity push in the wake of the financial crisis. During the downturn that began four years ago, developed countries increased their borrowing by hundreds of billions of dollars to support their financial systems and stimulate their economies, pushing national debts to levels not seen since World War II. When economic growth returned last year, the IMF initially focused on how to begin bringing that debt down.
Even relatively healthy countries like Germany began to cut their budgets. At the Group of 20 summit in Toronto last year, the world’s largest economies pledged to reduce annual budget deficits by half — precisely the type of promise the IMF now warns against.
Research published by the IMF last fall emphasized the possible costs of such austerity. Fund officials warned of slowing growth and rising unemployment if countries jointly cut too deep and too fast, especially since there are few public policies currently available to offset the effect of government austerity.
Central banks, which have already reduced interest rates to extremely low levels, have little remaining ability to boost economic activity. Nor do countries in the euro zone have the ability to stimulate their economies by devaluing the currency to increase exports. These countries are wired into a currency union with their most important trading partners, eliminating exchange rates as a policy tool.
Michael Mussa, a senior fellow at the Peterson Institute for International Economics and a former chief economist at the IMF, said the agency has offered prescriptions based on its best understanding of economic developments.
“As we moved from recession to recovery and the recovery looked strong, the emphasis shifted. . . . Now that things look weaker, it is natural to look for ways to get more expansionary policy,” he said.
Ahead of the fund’s annual meetings, IMF forecasters lowered their outlook for the global economy. The disturbing prospect is that developed countries may never fully bounce back from the 2008 downturn and could continue to face higher unemployment. The IMF wrote recently that “growth prospects are likely to remain subdued” over the coming years.
“The combination of a recession and a banking crisis takes a long time to get resolved,” said Nathaniel Karp, chief U.S. economist for the Spanish bank BBVA.