Christine Lagarde on Income Inequality, Brexit, and the Power of M&Ms

Lagarde spoke with Sergio Rebelo, a Kellogg School professor of finance, after her recent speech at the Kellogg School of Management. Their discussion was edited for length and clarity.

Rebelo: What do you see as the biggest risks to the global economy? What keeps you up at night? In your talk earlier today you mentioned trade protection and income inequality.

Lagarde: If you combine trade protection and income inequality, they can really have a massive, distorting, and negative effect on the global economy. Where I am prepared to spend some real political capital is on integrating women, making sure they’re not discriminated against.

Rebelo: Take a country like Japan that has been struggling to improve its growth prospects. The one silver bullet they haven’t yet used is to encourage more women to join the labor force.

Lagarde: Yes. In terms of the global picture, we see trade protectionism, barriers, rising populism, more exclusion causing more inequality and women being left out. I mean, that’s a pretty toxic mix.

Rebelo: What is your forecast for the outcome of the Brexit negotiations? How do you see the end game?

Lagarde: The measures taken so far, particularly by the Bank of England, have very much reduced the short-term risks associated with Brexit.

One asset of great value in the negotiations is the European “passport” for financial institutions, which provides British banks access to the markets in EU states. There are 500 passports being used by the UK banking system in order to operate in Europe and 800 passports used by all the other members of the Euro area in order to operate in the UK. On a per capita basis, the UK is a heavy user of these passports. The damage from losing them would be very significant for the UK.

Rebelo: Do you think the UK will end up making a deal with the EU similar to Norway’s?

Lagarde: Well, as I said before the referendum, what would be the point? As the Prime Minister of Norway said herself: What’s the benefit of it? You pay the same contribution, you are subject to the same regulations, and you’re not even sitting at the table.

Rebelo: Turning to continental Europe, the economic situation there is quite worrisome. There are very high levels of government debt in the periphery, high corporate and household debt. What could be done to alleviate the situation to create a little more room for growth?

Lagarde: There are some countries that are using their fiscal space. Germany is using some. Also, some of the Nordic countries that have space are also using it a bit. Countries have to take steps in the short term to stimulate the economy, but they also have to give direction and provide a medium-term fiscal anchor that reassures people.

Rebelo: To have a plan that specifies where they are going in the short and medium run.

Lagarde: That’s right: “We are spending because of low financing costs, a need for infrastructure, short-term impact on growth, and improvement of productivity down the road.” That’s the first brick, if you will.

The second brick is: “This is where we want to go. We want to directionally reduce our debt from where it is at the moment, and to do that, we will anchor our fiscal policy around a particular range that we will have independent experts help us define.”

Rebelo: Do you see in Germany any signs that they are more willing to increase government spending?

Lagarde: You know, I think so. Because, first of all, they are spending. They’re spending much more than anybody else at the moment on refugees. They have an infrastructure plan, which knowing the Germans, they will deliver upon. Tax cuts are now under active consideration, and Germany has also put development in Africa squarely on its G20 agenda—particularly for those countries that are exporting a lot of refugees— and is no doubt willing to support this priority through some additional spending.

Rebelo: Moving to the United States, how do you see the process of normalization of monetary policy unfolding? Is the US normalizing too slowly or too quickly? Traditionally, when the US raises its federal funds interest rate, there’s a lot of turbulence in the emerging markets, as investors rush back to the US. I know the IMF is putting in place some credit lines and safety nets, but can you comment what might happen in emerging markets as the US normalizes its monetary policy?

Lagarde: Well, first of all, we really believe that US monetary authorities should normalize on a data-dependent and well-communicated basis, so that it does not surprise markets, and it does not surprise colleagues in other countries either. I think Janet Yellen has been very specific that she will be data-dependent.

After the “taper tantrum,” a lot of the countries that had suffered from turbulence—Indonesia, India, some African countries— looked at their own monetary-policy toolbox.

You could see the difference between those who addressed that monetary turbulence with the right set of tools in the appropriate sequence and those who did not. Clearly, a country like India, which used monetary tools right away and comprehensively, reduced the impact of the tantrum.

Emerging markets had a second rehearsal in December when the Fed raised the Fed Funds rate. We did not observe much turbulence. I bet emerging markets will be even better prepared for the next rate hike.

Rebelo: Finally we are curious about whether you are going to write a book. Not a tell-all book, but a tell-all-that’s-interesting book about your experiences.

Lagarde: How to pack a bag. A book on that I can do! Some tips on dealing with impossible people. Or, how to use M&Ms.

Often people call me Madame M&Ms. I don’t really like M&Ms very much. But, when I was finance minister and we were negotiating difficult things—whether it was the European stability mechanism or the harmonized VAT rates—sometimes we had to work through the night.

So at 2:00 in the morning, you are still up and working, and you’re really starving. To find a pizza place at 2:00 in the morning in Brussels? Forget it. They’re all closed. So my trick was to pull out two big bags of M&Ms and to circulate them around the table. A little bit of sweetness and affection made the negotiations easier after that.

Rebelo: There’s the introduction to your book!

Lagarde: Yes, the role of sweets in negotiations.