Global economic growth is still stuck in low gear even though "the horizon is brighter."
That was the assessment of Christine Lagarde, International Monetary Fund managing director, who spoke before the National Press Club on Wednesday.
Unlike the Federal Reserve board, which has a watchful eye for signs of inflation, Lagarde said European bankers are concerned about a potentially dangerous downward spiral.
"With inflation running below many central banks' targets, we see rising risks of deflation, which could prove disastrous for the recovery," she said.
Lagarde said Spain had been on the verge of a deflationary spiral, but appears to have pulled out of it.
"If inflation is the genie, then deflation is the ogre that must be fought decisively," she said.
Lagarde said it is too early to tell whether the Federal Reserve's decision to reduce asset purchases will go smoothly. But she said central banks, including the Fed, must exercise extra care to avoid taking their collective feet off the gas pedal too soon.
So far, financial markets appear to be taking the Fed's $10 billion reduction in monthly asset purchases in stride, she said. But she warned, "There still could be rough waters ahead."
In the global financial system, attention must be paid in emerging markets to "any sign of financial excess, especially in the form of asset bubbles or rising debt," Lagarde said.
Also on the global front, financial regulation needs to be strengthened and implemented to better manage credit cycles.
Lagarde said the IMF will release its global economic outlook next week and will likely be an upgrade to its previous guidance. As a prelude, the World Bank this week said global growth is likely to rise to 3.2 percent this year from 2.4 percent in 2013 and strengthen further to 3.4 percent in 2015.
As to the global banking system, Lagarde said it was "certainly more stable than it was six years ago." She called for more attention to be given to "cross-border resolution" in winding down a failing international financial institution or bank.
As the first woman to lead the IMF, Lagarde was asked about the significance of Janet Yellen being named as the first woman to chair the Federal Reserve.
"It shows that women can do anything, particularly Janet," she said.
What do you think is the biggest risk facing the world economy? Are you worried more about inflation or deflation?
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