The new head of the IMF warned on Saturday that the global economy risks falling back into recession and called for urgent coordinated policy action, including the mandatory recapitalization of European banks.
"Developments this summer have indicated we are in a dangerous new phase," International Monetary Fund Managing Director Christine Lagarde said at an annual gathering of global policymakers hosted by the Kansas City Federal Reserve Bank. "The stakes are clear; we risk seeing the fragile recovery derailed. So we must act now."
Two years after the end of the worst of the recent financial crisis, growth in both the United States and Europe is sputtering, and debt crises on both sides of the Atlantic have shaken public confidence in a global recovery.
Advanced economies must forge long-term plans to bring their debt under control, but at the same time should not pursue belt-tightening so fast that it imperils recovery, Lagarde said on Saturday.
"Put simply, macroeconomic policies must support growth," the former French economy minister said in her first major policy speech since taking over the top IMF job from Dominique Strauss-Kahn in July.
"Monetary policy also should remain highly accommodative, as the risk of recession outweighs the risk of inflation," she said, adding that central bank should stand ready to jump back into unconventional policy actions if needed.
European banks need to be recapitalized, she said, adding that the most efficient way to do so would be "mandatory substantial recapitalization" through private channels if possible, but otherwise some form of public Europe-wide funding. Individual European countries must also put in place deficit-cutting plans with a "credible finance path" -- including, she said, continued support from the European Central Bank.
In the United States, the focus on long-term fiscal consolidation must not ignore the importance of fostering near-term growth, she said.
"After all who will believe that commitments to cut spending can survive a lengthy stagnation with prolonged high unemployment and social dissatisfaction?" she asked.
Policymakers must also stop the slide in the US housing market, she said, relying on intervention by government housing finance agencies and more aggressive programs to reduce homeowner debt.