As Labor’s ministerial razor gang plods along with the business of cutting spending to increase the size of Australia’s budget surplus, the head of that very economically conservative body the International Monetary Fund is calling on governments to loosen the purse strings.

Dominique Strauss-Kahn, the managing director of the IMF, declared at the weekend that the intensifying credit crunch is so severe that lower interest rates alone will not be enough “to get out of the turmoil we are in”.

In what the London Financial Times reported as a dramatic volte face for an international body that as recently as the northern autumn called for “continued fiscal consolidation” in the US, Mr Strauss-Kahn gave a green light for the proposed US fiscal stimulus package and called for other countries to follow suit.

“I don’t think we would get rid of the crisis with just monetary tools,” he said, adding “a new fiscal policy is probably today an accurate way to answer the crisis”.

Perhaps local interest rates will not be increased as the market expects. Reuters reported this morning that “markets here are pricing in about a 60 percent chance the Reserve Bank of Australia will lift its overnight cash rate by 25 basis points to 7 percent early next month, as it seeks to curb inflationary pressures.” But when the IMF starts calling for fiscal stimulus, there is obviously a belief that declining world growth will reduce inflationary pressures.

Mr Strauss-Kahn has certainly given those pundits, myself included, who called for Labor to abandon its promised $30 billion in tax cuts something to think about. Such cuts are exactly what he advocated to the luminaries meeting in Davos.

This is increasingly looking like one of those times in history where believing in conspiracy theory might not be so stupid. Dramatic cuts in US interest rates, a major economic spending stimulus by the US government and the IMF abandoning its advocacy of fiscal restraint point to me to the world financial system being in far worse state than those in positions of power have let on to the public.

I can but note that John Thain, the new chief executive of Merrill Lynch, predicted at Davos that the problems in subprime mortgage markets would spread to credit card and consumer loans.

“It will be a while before you see a return to normality in the banking system,” he said.

Perhaps it is time for Prime Minister Kevin Rudd to abandon his plan to show he is a tough economic conservative.

Peter Fray

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