This week, the president of the European Commission, José Manuel Barroso, declared the euro crisis over. On Jan. 7, he told reporters, "I think we can say that the existential threat against the euro has essentially been overcome." It was a shocking expression of denial, even for a member of the European policymaking establishment that has had its head in the sand since the beginning of the crisis. Fortunately, a new voice has emerged to disrupt the European echo chamber, that of International Monetary Fund chief Christine Lagarde.
Under Lagarde's refreshingly bold, imaginative, and courageous leadership, the IMF is at last proving to be an effective force in counterbalancing the excessive budget policy orthodoxy of the European Central Bank (ECB) and the European Commission (EC) in the search for ultimate solutions to the European economic crisis. She has delivered a desperately-needed reality check.
It's quite a turnaround. In the pre-Lagarde era, the IMF's record on Europe was nothing short of abysmal. In the run-up to the crisis, the IMF failed miserably in its oversight of the European economy, despite the fact that balance-of-payments problems were supposed to be its main area of expertise. Rather than sounding the alarm about outsized external current account deficits in the European periphery, the IMF bought into ECB President Jean Claude Trichet's now demonstrably mistaken view that balance-of-payments imbalances were of little concern in a monetary union with a single currency. That failure blinded the IMF to a crisis of epic proportions that still constitutes the most significant threat to the global economic recovery.
If the IMF's failure to anticipate the European crisis was regrettable, its handling of it was even worse -- revealing how little the fund had learned from previous economic and financial crises. Instead of addressing the crises in Greece, Ireland, Portugal, and Spain as the solvency problems that they were, the IMF approached them as a liquidity issue. More disturbingly yet, the fund threw its full weight behind severe budgetary austerity programs even though a euro straitjacket and a European credit crunch made those programs almost certain to fail.
Since taking over from Dominique Straus-Kahn in 2011, Lagarde has emerged as a courageous truth-teller to a European economic policymaking establishment that remains largely in denial about the severity of the crisis. In August 2011, in her first major policy speech as IMF chief, she broke the news to her European peers that the European banking system was undercapitalized by at least 200 billion euros, or around double the amount that the European policy establishment was prepared to admit. After taking considerable heat for her comments, subsequent events would prove that, if anything, her estimate was an underestimate of the true extent of European banks' capital problem, which is now estimated by the OECD to be around 400 billion euros.