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IMF Warns Against Prolonged Euro-Zone Deflation

 LONDON—The euro zone is risking a "prolonged period of deflation" if it doesn't do more to address the vicious circles that its debt crisis is creating, the International Monetary Fund said Tuesday.

In two special chapters in the new edition of its World Economic Outlook, the IMF urged the European Central Bank to cut its main policy rate and maintain its range of nonstandard measures to support the banking sector, and told the region's governments that they need to accept more direct responsibility for each other's risks, and for the risks faced by their respective banking systems.

"It is...critical to break the adverse feedback loops between sub-par growth, deteriorating fiscal positions, increasing bank recapitalization needs and deleveraging, which raise the risk of a prolonged period of deflation," the IMF wrote.

It advocated direct investment in banks by the euro-zone's rescue vehicles, as well as regionwide mechanisms for deposit insurance and bank resolution.

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