IMF's Lagarde warns on easy money, capital flows

Unconventional monetary policies helped make financial markets work again and took the worst risks off the table, but they must be carefully watched as they also increase other risks, Lagarde said in a speech at the Brookings Institution on Tuesday.

On balance, the policies have had a positive effect for the world, by improving global financial stability, boosting growth in advanced economies, lowering interest rates and lowering spreads, she said.

"Where would we be, where would yields be, where would spreads be without the ECB's Outright Monetary Transactions programme?" she said.

"For sure, the persistence of easy monetary policy increased the flow of capital to emerging markets, especially in Asia and Latin America," Lagarde said.

"Such flows can be beneficial to an economy, but they can also lead to financial stability risks. Even worse than the tide coming in is the tide going out—a possible sudden reversal of large capital flows that can overwhelm an economy."

The risks appear currently under control and can be managed with "sound macroeconomic policies complemented by macro-prudential policies geared toward taming financial excess" as well as by direct capital controls in some cases, she said.

While developing economies must continue their accommodative monetary policy, including unconventional measures such as quantitative easing, "the longer they last, the higher the volume, the bigger the risk," Lagarde said.

She also warned against using monetary policy as an excuse to avoid adjusting fiscal policy to a more balanced stance or to postpone structural and financial reforms. 

"Countries must use the breathing space offered by unconventional monetary policy to come to grips with underlying economic fragilities," Lagarde said.

Emerging markets were in strong positions when the crisis started back in 2007 and are still in positions of strength, with developing Asia and sub-Saharan Africa the two fastest-growing regions of growth in the world, she said.

But there have been recent signs of "slowing momentum" in some countries in the developing world.

"In China, recent activity has been weak and growth remains too reliant on credit, property development, and infrastructure. Investment prospects also look less bright in key markets like Brazil, India, Russia and South Africa," Lagarde said.

These countries need to apply domestic policies to deal with vulnerabilities and structural hurdles to growth such as problematic infrastructure, regulatory bottlenecks and governance issues, besides keeping "a watchful eye on spillovers from the advanced economies, especially from an extended period of unconventional monetary policy," she added.

Lagarde said that there were "glimpses of more somber trends" that suggest some slowdown in growth for the global economy.

"We could be entering a softer patch," she said.

- Follow us on twitter @emrgingmarkets