LONDON, Jan 30: Governments seeking to offset the global economic slowdown should look at targeted budgetary measures to boost demand and not rely solely on interest rate cuts, the head of the International Monetary Fund said on Wednesday.

Writing in the Financial Times a day after the IMF cut its 2008 global growth forecast, Managing Director Dominique Strauss-Kahn said that while lower interest rates were important they may have lost some of their traction in the current crisis.

“Timely and targeted fiscal stimulus can add to aggregate demand in a way that supports private consumption during a critical phase,” the IMF chief said. “Medium-term fiscal policy is all about saving for a rainy day. It is now raining.” The IMF forecast global growth would slow to a five-year low of 4.1pc this year, down from a previous 4.4pc call.

Fleshing out an argument for counter-cyclical fiscal policy first broached at the World Economic Forum in Davos at the weekend, Strauss-Kahn said lower interest rates were appropriate as long as inflation expectations remain in check.

“The first line of defence remains monetary policy.” But he said monetary policy may not be enough as the transmission mechanism may well be “damaged”.

“While cutting interest rates is still effective, it may not work to stimulate investment and consumption as fast as usual,” Strauss-Kahn wrote.

“Banks have suffered substantial capital losses and thus want to consolidate their balance sheets and avoid taking on additional risk,” he added, arguing normally low-risk assets such as jumbo US mortgages are now regarded as higher-risk and this may lessen the impact of short-term rate cuts.

The IMF head said there was also a risk many countries may find it hard to shake off this economic downturn quickly as households that have depended on house price and equity growth for savings are forced to save more from incomes instead.

As a result, a mix of fiscal and monetary measures was worth considering. Strauss-Kahn said the extent of fiscal stimulus that was appropriate would vary from country to country.

“Countries that have fiscal and monetary space should consider now what it would take to line up a temporary fiscal stimulus that can be deployed quickly if needed as events unfold in 2008,” he said.

“Of course, there are risks to this use of fiscal policy,” he said. “But doing nothing raises the risk of very bad outcomes.—Reuters