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Christine Lagarde, Managing Director of the IMF, is. photographed during a visit toToronto, Ont. on Oct. 25, 2012. (Peter Power/The Globe and Mail)
Christine Lagarde, Managing Director of the IMF, is. photographed during a visit toToronto, Ont. on Oct. 25, 2012. (Peter Power/The Globe and Mail)

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Deficit deal crucial for U.S. to avoid another recession, IMF chief tells The Globe Add to ...

The United States is in danger of falling back into recession if its politicians cannot agree on how to avoid a “fiscal cliff” of tax increases and spending cuts, warns the head of the International Monetary Fund.

In an interview with The Globe and Mail, Christine Lagarde said that a failure by the leaders of the world’s largest economy to come up with a fiscal plan would have “dire economic consequences” – and is a major risk to a Canadian economy that has outperformed most other industrialized countries.

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Her comments underscore the high stakes in the Nov. 6 election, which is shaping up as a tight race between President Barack Obama and Republican challenger Mitt Romney. The two have offered sharply different visions of how to solve the country’s fiscal mess, which has seen Washington run budget deficits of more than $1-trillion (U.S.) every year since the devastating financial crisis of 2008-09.

The term “fiscal cliff” refers to a series of tax hikes and budget reductions that would automatically come into effect at the end of the year unless Congress and the White House can come up with an alternative plan for the budget. Most economists agree that the result would be a sudden loss of momentum for an economy that has been slow to recover from the crisis, and that only recently has been able to drive its unemployment rate below 8 per cent. About 12 million Americans remain out of work.

The IMF’s own projections suggest that hitting the fiscal cliff would reduce U.S. economic growth by 2 percentage points – a drop that would wipe out all of its potential growth next year, said Ms. Lagarde, the former French finance minister who left that post in 2011 to become the IMF’s managing director.

“It’s [an issue] that can be resolved and addressed politically. But it has dire economic consequences,” she said during a brief visit to Toronto, where she was presented with an award by the Canadian International Council.

Asked if those consequences included a serious recession, Ms. Lagarde said: “Yes. Yes. Or certainly a recession.”

Many experts still believe that whatever the results of the election, Republicans in Congress and the Obama administration will be able to cut a deal to forestall an economic disaster. Even if Mr. Romney wins, he will not become president until Jan. 20, 2013. But the dramatic events of the summer of 2011, when the two sides fought until the last moment over an agreement to raise the federal government’s debt limit, shook the public’s faith in the ability of Washington’s major parties to find compromise.

Ms. Lagarde said that, along with the long-running sovereign debt crisis in Europe, the U.S. fiscal situation remains her chief concern about the world economic outlook. The IMF this month cut its forecast for global growth for 2012 to 3.3 per cent, the slowest rate since 2009.

“Will the debt ceiling be addressed? Will [the U.S. government] make payroll at the end of the January? And what is the medium-term credible plan for that country to reduce its deficit and to change its debt trajectory? I think those are big questions as well.”

Canada’s reliance on the United States as its major trading partner “clearly exposes it to the potential downside or the risk of a recession in the United States of America.”

The IMF has also expressed worry about the record levels of household debt in Canada; the average is 1.63 times income and has been rising steadily as consumers borrow more in order to buy increasingly expensive homes.

But while those risks are real, the IMF chief stressed that Canada is an “anomaly” among developed nations because of its relative economic health.

“If I look at Canada and the anomaly that it constitutes compared to other countries – because it’s growing pretty well, because its banking system is solid and growing, because its inflation is under control, because its fiscal deficit is also pretty much under control and its level of indebtedness is reasonable – you know, it’s not bad as a scorecard.”

But residents of the world’s major economies will probably have to be satisfied with slower growth rates than they are accustomed to, Ms. Lagarde hinted. And they are already responding by changing their behaviour, which is changing the nature of their economies.

“We’re seeing the pattern evolve. If you look at the savings rates of the U.S. consumers, for instance, it is changing. They are more into saving and less into consumption.”

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