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Lagarde focused in
her speech on the fragility of European banks, and the continuing drag
that the US housing crisis has on economic confidence.
She said the fundamental problem is that in
these advanced economies, weak growth and weak balance sheets - - of
governments, financial institutions, and households - - are feeding
negatively on each other. If growth continues to lose momentum, balance
sheet problems will worsen, fiscal sustainability will be threatened, and
policy instruments will lose their ability to sustain the recovery.
The IMF managing director said European
banks must be strong enough "to withstand the risks
of sovereigns and weak growth. This is the key to cutting the chains of
contagion. If it's not addressed, we could easily see the further spread of
economic weakness to core countries, or even a debilitating liquidity
Lagarde said each country needs a dual focus:
a primary emphasis on durable measures that will deliver savings
tomorrow which, in turn, will help to create as much space as possible
for supporting growth today - - at least by permitting a slower
pace of consolidation where possible. For instance - - measures that change
the rate of growth of entitlements, health or retirement.
On European banks, Lagarde said they
must be strong enough to withstand the risks of sovereigns and weak growth.
"This is key to cutting the chains of contagion. If
it is not addressed, we could easily see the further spread of economic
weakness to core countries, or even a debilitating liquidity crisis. The
most efficient solution would be mandatory substantial recapitalization - -
seeking private resources first, but using public funds if necessary. One
option would be to mobilize EFSF (rescue fund) or other European-wide
funding to recapitalize banks directly, which would avoid placing even
greater burdens on vulnerable sovereigns."
Jean-Claude Trichet, ECB president,
told the same forum that European banks should move to reinforce their
balance sheets. But he dismissed worries about a liquidity crisis, saying
the extraordinary lending the ECB has offered means such concerns are
"just plain wrong."
On the response to the Eurozone debt crisis,
Lagarde said that an unclear or confused message will add to market
uncertainty and magnify the Eurozone’s economic tensions. So Europe must
recommit credibly to a common vision, and it needs to be built on solid
foundations—including, for example, fiscal rules that actually work.
On the United States, Lagarde said
"credible decisions on future consolidation - - involving both revenue and
expenditure - - create space for policies that support growth and jobs today. At
the same time, growth is necessary for fiscal credibility - - after all, who
will believe that commitments to cut spending can survive a lengthy stagnation
with prolonged high unemployment and social dissatisfaction?" she asked.
The second priority for the US is
halting the downward spiral of foreclosures, Lagarde said.
President Obama plans to announce a
set of economic proposals, early next month, after Labor Day.