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Lagarde stance on interest rates may vex US

Why advice is sometimes best behind closed doors

by David Marsh

Mon 8 Jun 2015

Christine Lagarde, managing director of the International Monetary Fund, may be complicating decision-making over a US interest rate rise through last week’s advice to the Federal Reserve to hold off a rate hike to early 2016.

She may not have done much good, either, to her chances of re-election when her five year mandate ends in July 2016.

Whether or not Lagarde wishes to run for a second term is open to conjecture. Support among advanced and emerging economies alike for a new managing director – this time from Asia, Latin America or Africa – may be stoked by a feeling that the Fund has not always played a steady hand during unfolding economic debates.

Lagarde’s statement that the US economy should grow 2.5% this year but a rate hike should wait until 2016 came a day before Friday’s exceptionally robust US jobs data release. This showed a better-than-forecast 280,000 rise in non-farm payrolls in May, along with upward revisions to the previous two months and an increase in the average earnings growth to the highest for nearly two years.

Many in the markets are now pricing in a rate hike in the autumn. While Lagarde’s intervention will not be a pivotal factor, her intervention may irritate some on the Federal Open Market Committee who believe that the IMF chief may be overstepping the mark by giving public advice on the timing of interest rate decisions. A better outcome would have been for Lagarde on Thursday to have pointed to the risks involved in an early Fed rate rise, but to have refrained from any direct statement on timing.

The IMF has made a series of questionable policy calls in recent years. One of the most notable was the 2010 step to give Greece a €30bn loan as part of an international bail-out, 3,212% of quota (a record), a decision that is haunting the IMF five years afterwards.

As an internal Fund assessment in 2013 concluded, the decision was made on massively over-optimistic assumptions and, crucially, in the misguided belief that Greece’s public finances would be sustainable in the medium term. Although providing the funds was decided under the stewardship of Dominique Strauss-Kahn, Lagarde’s predecessor, she played a strong role as French finance minister in proposing Greece’s exceptional Fund access.
Other less-than-glittering milestones include the Fund’s ill-placed 2013 criticism of the British government’s economic policy, which it later had to modify, and Lagarde’s agitation for quantitative easing in Europe which arguably, too, complicated decision-making when it eventually came at the beginning of this year.

The benefits of QE in Europe have been higher money supply growth which is working through now to higher inflation, as well as a lower exchange rate which has been helpful for competitiveness. However some of these results may have emerged anyway as a result of the considerable liquidity boost and interest rate cuts enacted by the European Central Bank in advance of the January move.

The drawbacks to QE have been discernible all along, but are only now starting to become fully evident, in the form of additional volatility and market distortions caused by introducing heavy-duty asset purchases at a time of already-low interest rates and diminished bond issuance by triple-A government borrowers.

When the history of Lagarde’s time as the IMF is written, the conclusion may be that the managing director would have been more effective giving advice behind closed doors rather than behind a megaphone.

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