IMF director wants more aggressive European policies to stem debt crisis, raises fears of depression

The opening lines from the Bloomberg piece Lagarde Urges Larger European Rescue Fund, Recommends Eurobonds pretty much say it all:

International Monetary Fund Managing Director Christine Lagarde urged European policy makers to increase their bailout fund and share fiscal risks, including through a joint bond, to prevent the region’s debt turmoil from becoming a 1930s-style worldwide depression.

“We need a larger firewall,” Lagarde said in prepared remarks for a speech in Berlin today. “Without it, countries like Italy and Spain, that are fundamentally able to repay their debts, could potentially be forced into a solvency crisis by abnormal financing costs.”

Lagarde’s comments reflect concern from the rest of the world that Europe hasn’t done enough to quell a fiscal crisis now in its third year, at a time when the IMF co-finances loans to Greece, Ireland and Portugal. In their latest effort to address the turmoil, European finance ministers meet in Brussels today to discuss new budget rules, a financial firewall to protect indebted states and a Greek debt swap.

I’ve been writing about this issue every now and then, and have been following the news from Europe more closely than ever before in my life. It’s been clear for well over a year that Eurozone leaders, the ECB, and others with a stake in solving the continent’s financial crisis are not doing enough to extinguish the crisis. The odds that Greece will default on its debt and leave the Euro are uncomfortably high, and there seems no clear way to contain the crisis if it erupts catastrophically in Greece or another country.

And it increasingly seems that austerity plans demanded by the ECB and others are dampening economic growth in some countries, thus reducing economic activity and jeopardizing projected government revenues while at the same time threatening political destabilization. For more background, take a look at Robert Shiller’s Does Austerity Promote Economic Growth?

Lagarde is obviously worried about those extreme austerity measures too. More from Bloomberg today:

“Although the economic outlook remains deeply worrisome, there is a way out,” Lagarde said. “Now the world must find the political will to do what it knows must be done.”

Not all European countries need to quickly tighten public finances, Lagarde said, mentioning a “large core” where reducing the deficit can be more gradual.

“Those with fiscal space should support the common effort by reconsidering the pace of adjustment planned for this year,” she said, just as European governments negotiating a new fiscal treaty are hewing to an agenda championed by German Chancellor Angela Merkel that puts stiffer rules on deficit control.

If there’s too much dithering from European leaders on these issues, we’ll eventually hit a point where the sovereign debt crisis will spin out of their control.