IMF’s Lagarde Urges Support for World Economy in a ‘Dangerous New Phase’

Christine Lagarde, the new managing director of the International Monetary Fund chief, warned that the world economy is in a “dangerous new phase” and that officials must take new steps to strengthen growth.

Lagarde, speaking to international finance officials and economists in Jackson Hole, Wyoming, said the U.S. should arrest a slide in house prices and European banks must be required to boost capital to prevent the continent’s debt crisis from infecting more countries. The U.S. and European Union should 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 $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 expansion of the world economy and predicted major central banks will leave interest rates on hold through 2012.

“Risks have been aggravated further by a deterioration in confidence and a growing sense that policymakers do not have the conviction, or simply are not willing, to take the decisions that are needed,” Lagarde said.

‘Stakes are High’

The slowdown provided the impetus for three days of debate at the conference, with Federal Reserve Chairman Ben S. Bernanke saying the U.S. 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 ($3.6 billion) capital shortfall, failing to ease concern that many of them remain vulnerable to a potential sovereign default.

Without an “urgent” recapitalization, “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.”

‘Accomodative’ Monetary Policy

Central bankers should also keep monetary policy “highly accommodative, as the risk of recession outweighs the risk of inflation” and should stand ready “to dive back into unconventional waters.” The Fed this month pledged to keep its key interest rate near zero until at least mid-2013.

Emerging economies have a part to play too, Lagarde said, adding that some “key” nations are curbing domestic demand and preventing their currencies from strengthening. Such steps prevent emerging markets from making a bigger contribution to global growth.

“Everyone should recognize that decoupling is a myth,” she said. “If the advanced countries succumb to recession, the emerging markets will not escape.”

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