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 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.”

‘Substantial’ Recapitalization

The former French finance minister, who took the helm at the Washington-based IMF in July, said recapitalization should be “substantial” and called a mandatory move “the most efficient solution.” Banks should seek funds in financial markets first and later public money if necessary, including from the 440-billion euro European bailout fund, she said.

European Central Bank President Jean-Claude Trichet echoed Lagarde’s call for banks to strengthen their balance sheets, while saying any talk of a liquidity crisis is “plain wrong” because his institution has taken steps to aid banks, offering them unlimited cash for up to six months.

Attending his final Jackson Hole conference before retiring in October, Trichet, 68, avoided mentioning the debt crisis at length, preferring instead to defend the euro against critics who say its members are too diverse to unite under a single currency. He used new research to show how the U.S. has regional divergences similar to the euro area’s and noted how Europe has grown almost as quickly and generated more jobs as the U.S. in the past decade.

Job Creation

While Lagarde urged lawmakers to shrink budget deficits over time, she said they could still take steps now to stimulate expansion. Making European budgets more sustainable “does not necessarily mean drastic upfront belt-tightening” because by addressing long-term risks such as rising pension costs, governments will have more leeway in the short term to fund policies that support job creation, she said.

That’s also true in the U.S, where Lagarde called for “decisions on future consolidation -- involving both revenue and expenditure.” She also called for more aggressive policies on housing to halt “the downward spiral of foreclosures, falling house prices and deteriorating household spending.” These could include reducing principal payments for homeowners or helping them refinance mortgages at lower interest rates, she said.

‘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.”