- Associated Press - Tuesday, January 24, 2012

A recession in Europe will slow the global economy this year, the International Monetary Fund predicted Tuesday, while urging world leaders to focus on growth more than on budget cuts.

The IMF forecast global growth of 3.25 percent this year, slower than the 4 percent pace it projected in September. The 17 nations that share the euro will drag the rest of the world down, according to the IMF, which now says their economies will shrink 0.5 percent this year, against a September forecast of 1.1 percent growth for the region.

Europe’s recession should have only a modest impact on the United States, the IMF predicted, projecting 1.8 percent growth for the year, unchanged from its September estimate.

Steep budget cuts will slow growth further and undermine market confidence, the IMF said, advice that runs counter to the push for budget cuts advocated by German Chancellor Angela Merkel.

“The world recovery, which was weak in the first place, is in danger of stalling,” Olivier Blanchard, the fund’s chief economist, said at a news conference. “The epicenter of the danger is Europe.”

European governments should avoid extreme austerity measures - spending cuts and tax increases - in weaker economies, such as Italy and Spain, the IMF said in its World Economic Outlook. And healthier European countries whose governments are facing lower interest rates “should reconsider the pace” of their short-term budget cuts.

“The good news,” Mr. Blanchard said, is that “with the right set of measures, the worst can be avoided, and the world can be set back on track.”

IMF managing director Christine Lagarde made a similar argument Monday during a speech in Berlin.

Many European governments do need to cut deficits, Mr. Blanchard said, “but at an appropriate pace.”

It may take two decades or longer to pay off the debts accumulated during the 2008 financial crisis and global recession, Mr. Blanchard cautioned, noting that it took that long to pay off the debts Europe ran up during World War II.

European governments should also build up the region's permanent bailout fund, Mr. Blanchard said, calling it a necessity for supporting larger nations, such as Italy and Spain, that are paying high interest rates on their debts.

Last week, the IMF said it is seeking $500 billion to boost its own resources in the event more lending is needed in Europe or elsewhere.

European banks, meanwhile, are cutting back on lending in order to boost their capital reserves, the fund said. That’s likely to hammer Central and Eastern European economies this year, which depend heavily on European bank loans.

The cutbacks will also slow growth in many Asian economies because European banks finance a big chunk of that region’s exports, the IMF said.

Still, the hit to China will be relatively modest: It is forecast to grow 8.2 percent this year, down from the fund’s earlier projection of 9 percent.

U.S. policymakers should take steps to rein in the long-term costs of government health programs and Social Security, the IMF said, while making a caveat similar to its advice to Europe by saying those cuts should be phased in over the long-term rather than immediately from fear of slowing the economy further.

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