The head of the International Monetary Fund today urged advanced countries to take bold, coordinated action to break a vicious cycle of weak growth and high debt that threatens the global economy and has been worsened by dysfunctional politics.
Without collective, bold action, there is a real risk that the major economies slip back instead of moving forward, IMF Managing Director Christine Lagarde said in her first major Washington speech since she assumed her post in July.
She warned that the world economy had entered a dangerous new phase with global growth slowing as advanced economies struggled with an anaemic and bumpy recovery.
In contrast, emerging economies faced overheating pressures with inflation rising, strong credit growth and expanding current account deficits, she said.
Lagarde said timid growth and weak public balance sheets in developed nations were feeding negatively on each other, fuelling a crisis of confidence and restraining demand, investment and employment.
This vicious cycle is gaining momentum and, frankly, it has been exacerbated by policy indecision and political dysfunction, she said.
A bitter political fight over US debt in Washington during the summer and questions about Europe's ability to contain an escalating debt crisis has shaken business, consumer and global financial market confidence, putting a brake on growth. The focus in Europe has been on Greece, with financial markets questioning whether the 17-nation euro zone will be able to keep Athens afloat.
Lagarde said she was reassured by a joint statement from German Chancellor Angela Merkel and French President Nicolas Sarkozy. The leaders said Greece would stay in the Euro zone in comments meant to defuse market concerns Athens could drop out of the currency bloc.
It is a clear indication from them, who are the two clear leaders from an economic point of view in that Euro zone of 17 members, that the future of Greece is within the Euro zone, Lagarde said in answer to a question.
Keeping Greece in the Euro zone would, however, come at a price, she said, adding that Greece had only partly implemented the austerity measures called for under an IMF-European Union rescue.
It is a question of reigniting the urge to actually deliver under the commitments that were made by the Greek government and by parliament, she said.
The joint political efforts by France and Germany this week over Greece was exactly what was needed to restore confidence, she said, recalling the effective coordinated response in 2009 by major economies to tackle the global financial crisis.
The steps taken in 2009 at the height of the financial crisis are credited with short-circuiting global panic and restoring economic growth. Lagarde urged leaders in the United States and Europe to develop credible medium-term plans to lower debt. But she cautioned governments that consolidating budgets too quickly would hurt the recovery and hurt job creation.
The challenge is to navigate between the twin perils of losing credibility and undermining growth, Lagarde added.
She also said leaders in the Euro zone must ensure that all banks are properly capitalized.
She said financial sector reforms should be a global priority. While there was broad agreement on capital and liquidity standards for banks, there were still substantial gaps in areas like supervision, cross-border resolution and shadow banking systems, Lagarde added.