Fresh global pact targeting growth required after IMF admits it underestimated the damage austerity would cause in EU

The International Monetary Fund's belated admission that it significantly underestimated the damage that austerity would cause to European Union growth rates highlights the self-defeating character of "orthodox" recipes to address the causes of the debt crisis that followed the financial crash of 2008-09.

Conventional theory suggests that a single country (or group of countries) consolidating its finances can expect lower interest rates, a weaker currency and an improved trade position. But since this cannot happen for all major economies simultaneously - one country's (or group of countries') austerity implies less demand for other countries' products - such policies eventually lead to beggar-thy-neighbor situations. Indeed, it was this dynamic that made the Great Depression of the 1930s so grim - and against which John Maynard Keynes fought.

Today's problems are compounded by a lack of sufficient private demand - particularly household consumption - in the advanced economies to compensate for demand losses stemming from austerity. During the past two decades, consumption drove these countries' economic growth, reaching historically high GDP shares.

Moreover, major advanced economies, such as the United States, Germany and Japan, face longer-term fiscal problems in the form of aging populations or oversize welfare states, limiting their capacity to contribute to demand management. Recent moves to ease monetary policy have been a step in the right direction; but, so far, they have not proved to be a game changer.

For domestic demand to act as an engine of growth, policies should shift resources from investment to consumption. While the magnitudes involved are huge, they must be attained if an extended period of low growth, high unemployment and declining living standards among the world's poorest is to be avoided.

International economic policy coordination should be significantly strengthened to deal effectively with changes on such a scale. It should start with Europe. It is by now patently obvious that austerity and domestic reforms are not enough to pull the eurozone's periphery out of deep recession. Growing awareness of the failure of current policies is causing social discontent, civil disorder and political instability, with the recently concluded Italian elections and the growing popular resistance to Greek reform efforts serving as a bellwether.

Returning the eurozone's peripheral economies to the path of growth requires more than structural reforms and fiscal consolidation. It also requires a substantial reform of the monetary union's system of economic governance, aimed at restoring financial stability and lowering borrowing costs, together with a boost to external demand in order to compensate for the effects of austerity.

Reforming governance implies significant progress toward economic unification: centralizing European debt through eurobonds, mobilizing sufficient rescue funds, allowing the European Central Bank to intervene in the primary bond markets, and establishing both a fiscal and a banking union.