Speaking to international finance officials and economists in Jackson Hole, Wyoming, new IMF managing director Christine Lagarde warned that the world economy is in a “dangerous new phase” and that officials must take new steps to strengthen growth.
The US should arrest the slide in house prices and European banks must be boost capital to prevent the continent’s debt crisis from infecting more countries, while the US and EU need to enforce long-term budget discipline to free up cash for short-term stimulus, she said.
“We risk seeing the fragile recovery derailed,” Lagarde, 55, said. “So we must act now.”
Lagarde spoke near the end of a month when the value of global -equities dropped by US$5.7 trillion on concern global growth is slowing and governments will be unable to tackle sovereign debt burdens.
UBS AG and Citigroup Inc cut their forecasts for the expansion of the world economy and predicted major central banks will leave interest rates on hold through next year.
The slowdown provided the impetus for three days of debate at the conference, with US Federal Reserve Chairman Ben Bernanke saying the US central bank still has tools to boost its economy, without specifying what they were or whether they would be deployed.
“The stakes for the world economy are high,” said Allen Sinai, president of Decision Economics in New York, who put the odds of another global recession at 30 percent.
Europe is struggling to contain a sovereign debt crisis that is nearing its third year and has left many banks from Spain to Greece in or close to insolvency. Stress tests on 90 European banks published on July 15 showed eight lenders had a combined 2.5 billion euro (US$3.6 billion) capital shortfall, failing to ease concerns that many of them remain vulnerable to a potential sovereign default.
Without an “urgent” re--capitalization, “we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis,” Lagarde said.
Bolstering banks’ -balance sheets “is key to cutting the chains of contagion,” she said.
The former French finance minister said re-capitalization needed to be “substantial” and called a mandatory move “the most efficient solution.” Banks should seek funds in financial markets first and later public money if necessary, including from the 440 billion euro European bailout fund, she said.
European Central Bank (ECB) President Jean-Claude Trichet echoed Lagarde’s call for banks to strengthen their balance sheets, while saying any talk of a liquidity crisis is “plain wrong” because his institution had taken steps to aid banks, offering them unlimited cash for up to six months.
Attending his final Jackson Hole conference before retiring in October, Trichet, 68, avoided mentioning the debt crisis at length, preferring instead to defend the euro against critics who say its members are too diverse to unite under a single currency.
While Lagarde urged lawmakers to shrink budget deficits over time, she said they could still take steps now to stimulate expansion. Making European budgets more sustainable “does not necessarily mean drastic upfront belt--tightening,” because by addressing long-term risks such as rising pension costs governments will have more leeway in the short-term to fund policies that support job creation, she said.