Unlike in the first wave of global crisis in 2008, governments have fewer tools to address the simmering problems, Lagarde acknowledged.
But there remain solutions, including addressing long-term debt problems in the United States and Europe while moving cautiously in the near term; addressing problems in the U.S. housing market that are making it hard for Americans to get out from under their debts; and recapitalizing European banks.
The comments came near the close of an annual gathering of central bankers and leading economists from around the world, which occurs each year in the Grand Teton mountains and is organized by the Federal Reserve Bank of Kansas City. At the same event on Friday, Federal Reserve Chairman Ben S. Bernanke said the U.S. economy will ultimately return to its pre-crisis prosperity, but that it will take good policy decisions to get there.
Lagarde issued more of a call to arms to the central bankers.
“We must act now, act boldly and act together,” said Lagarde, calling for a coordinated plan of attack on the simmering new crisis by officials on both sides of the Atlantic.
The U.S. and European governments must simultaneously move to reduce long-term budget deficits and provide more support for job creation today, she said.
“It does not necessarily mean more upfront drastic belt-tightening,” Lagarde said. “If countries address long-term fiscal risks like rising pension costs or health-care spending, they will have more space in the short run to support growth and jobs.”
And she said the U.S. government should intervene more in the housing market to help reduce the burden of mortgage debt. She argued for more aggressive programs to help homeowners who owe more on their mortgages than their homes are worth, stronger intervention by housing finance firms Fannie Mae and Freddie Mac, and policies to help more homeowners refinance to take advantage of low mortgage rates.
European officials also need to rein in their longer-term finances in ways that do not cut spending so rapidly as to undermine growth, Lagarde said. And European nations need to strengthen the finances of their banks by helping them add more capital — perhaps using a financial stability fund established by European governments last year as a mechanism to bail out Greece and other nations.
More fundamentally, she said, Europe’s governments need to deepen their political connections. “The current economic turmoil has exposed some serious flaws in the architecture of the euro zone, flaws that threaten the sustainability of the entire project.”
Lagarde also said that central banks should continue pumping money into the world economy to try to boost growth. “Monetary policy also should remain highly accommodative,” she said, “as the risks of recession outweighs the risk of inflation . . . policymakers should stand ready, as needed, to dive back into unconventional waters.”
Jean-Claude Trichet, president of the European Central Bank, who leads the setting of monetary policy for the 17 nations that use the euro currency, was speaking on the same panel but avoided such specific endorsements of new policy action. He did, however, urge vigilance amid an uneven economic situation.
“All advanced economies are put into stress,” Trichet said. “The business model of the U.S., Japan, the U.K. are all under question.” Europe as a whole, he noted, has a lower budget deficit than the United States and Japan. But, “the problem is that we are challenged in our governance.”