IMF, OECD hit alarm buttons for crisis-hit global financial system

PARIS, March 17, 2008 (AFP) – The IMF and OECD, two top world economy forecasters, struck alarmist notes Monday about crisis and threatening stagflation in the financial system and the need for measures to shore it up as markets sent distress signals. Only hours after the US Federal Reserve took emergency weekend action to keep the US financial system afloat with cash, the head of the IMF warned that the world economy was being hit by an “important slowdown.”

Consequently, IMF growth forecasts would be cut further because of the crisis. “The downside risks have materialised.” “Obviously the financial market crisis is now more serious and more global than a week ago,” Dominique Strauss-Kahn said, warning that there was a “risk of (it) worsening.” The crisis would be long, would hit hard and spread to emerging economies, he predicted.

So far, central banks had managed problems of liquidity in the financial system well and he said he had “no reason to believe they won’t be able to” in coming weeks. “At this time, the priority for European governments should be containing the economic damage from the financial market crisis,” he told a joint conference with the OECD. “This is difficult because we are in an economic environment where inflation and recession are both potential problems.”

And the head of the Organisation for Economic Cooperation and Development said that financial authorities had to send signals that they were ready to do everything needed to shore up the financial system and avoid systemic risks.

OECD secretary general Angel Gurria said the priority had to be stability of the system: “In the short term (they) have to send out a signal” such as the rescues of the British Northern Rock bank and of US investment bank Bear Stearns at the weekend.

As they spoke at an IMF-OECD conference on structural reforms of European economies, the dollar slumped to another record low point against the euro, shares fell sharply around the world, the price of oil rose to close to 112 dollars and gold remaind near record levels.

NTT Smarttrade director Takashi Kudo, analysing emergency action by the Federal Reserve including a cut in a key interest rate late on Sunday, said: “Investors seem to have taken these moves as evidence of the deepening of the credit crisis.” However, the German government sought to reassure, saying: “There is no indication of further charges for the German financial market.”

Strauss-Kahn insisted that the crisis only highlighted the need for structural reforms in European economies to increase their competitiveness and productivity so that they could generate the growth needed to sustain the European model of justice and dignity.

His reference to inflation and recession revives talk of possible stagflation. This is a combination of rising prices, which forces central banks to keep short-term interest rates high, and slowing growth to which they would normally respond by easing short-term rates.

Analysts have warned that stagflation could become a problem again as the fallout from the US housing market collapse hits the US economy and sparks a flight into commodities such as gold and oil, which in turn forces up inflation. Over the weekend, the US Federal Reserve announced measures to improve liquidity and helped the bailout of Bear Stearns, the fifth-biggest US investment bank that had come close to failure on Friday.

Strauss-Kahn argued that “it may also be that a sense of crisis can help mobilise support for reforms.” He said: “This may seem like a strange time to be holding a conference on structural reform. We are in the middle of a financial crisis which will have significant implications for many countries.”

But reform could have a big bearing on how Europe emerged from the crisis so “that we can achieve a balance between economic prosperity, social justice and the environment.” He said: “In an economic environment such as this, governments and citizens should also be interested in reforms that can promote growth without inflationary risks. That is the kind of labour and product market reforms that we are talking about at this conference.”

Europe had to compete successfully in world markets and achieve high growth, which meant labour markets had to focus on encouraging new jobs rather than on “only protecting old ones,” with an accompanying shift on social safety nets.