Europe doesn’t lack funds, just political will

The following article was written in response to 'Only the IMF can solve eurozone crisis' by Ragharam Rajan, published in the Financial Times, 26 September 2011.

The current strategy for addressing the crisis has failed and International Monetary Fund’s official support for that strategy is a threat to the organisation’s credibility. But it is unclear what purpose greater IMF involvement would serve. Increased funding, as suggested by Mr Rajan, would provide a stopgap, but not a solution to the key problem facing the indebted members of the eurozone: how will they generate economic growth?

IMF involvement, along the lines suggested – additional firepower, but more of the same in terms of policy prescriptions – will not provide a long-term solution to the euro crisis but would pose a further threat to the IMF’s credibility. Why, the emerging economies would rightly ask, is the IMF getting ever more involved in what is essentially an internal European political problem? The debtors and creditors are both members of a currency union, which also happens to be one of the wealthiest regions in the world. It is up to Europe to sort out this mess. It is not that Europeans lacks the firepower to deal with the crisis: they lack the political will to acknowledge the implications of their creation.

The eurozone needs debt mutualisation, not an IMF programme. But it also needs expansionary macroeconomic policies. There is no devaluation option for the likes of Spain and Italy, so if they are to cut their costs relative to Germany – without experiencing deflation and debt traps – German inflation will need to rise more quickly than the current projections of around one per cent. Aggressively expansionary fiscal policy (in those countries with the scope) and a massive programme of unsterilized bond purchases by the European Central Bank, would help arrest the slide in stagnation and debt deflation. The inflationary implications of such a strategy should not be feared. Without some inflation, the euro is not going to survive.