The most urgent economic priority for European governments is to limit the damage from "the financial market crisis" amid threats of inflation and recession, the head of the IMF said here on Monday.
The crisis would be lengthy, would have serious economic consequences and would spread from the United States and developed countries to affect emerging economies, the director general of the IMF, Dominique Strauss-Kahn warned.
"At this time, the priority for European governments should be containing the economic damage from the financial market crisis," he told a joint conference with the OECD.
"This is difficult because we are in an economic environment where inflation and recession are both potential problems."
Stagflation is the combination of rising prices, which forces central banks to keep interest rates high, and slowing growth, when they would normally reduce lending costs so as to bolster the economy.
Analysts have wared that stagflation could become a problem again as the fallout from the US housing market collapse hits the US economy and sparks a flight into commodities such as gold and oil which in turn forces up inflation.
Over the weekend, the US Federal Reserve announced a series of measures to improve liquidity and helped the bailout of Bear Stearns, the fifth largest US investment bank which collapsed Friday.
Strauss-Kahn, in Paris for a joint conference with the Organisation for Economic Cooperation and Development on structural reform in Europe, noted that "it may also be that a sense of crisis can help mobilise support for reforms.
"In an economic environment such as this, governments and citizens should also be interested in reforms that can promote growth without inflationary risks. That is the kind of labour and product market reforms that we are talking about at this conference."
Strauss-Kahn, a former Socialist finance minister in France, was speaking the day after strong Socialist gains in French local elections to which the reforming right-wing administration of President Nicolas Sarkozy has responded by saying that reforms will not be watered down, but pursued and even accelerated.
Strauss-Kahn, who used the word crisis four times in remarks prepared for his address, stressed that European governments had to progress with reforms to their economies to provide the growth needed to sustain the European model of justice and dignity.
"This may seem like a strange time to be holding a conference on structural reform," he said. "We are in the middle of a financial crisis which will have significant implications for many countries.
But reform could have a big bearing on how Europe emerges from the crisis so "that we can achieve a balance between economic prosperity, social justice and the environment."
Europe had to compete successfully in world markets and achieve high growth, which meant labour markets had to focus on encouraging new jobs rather than on "only protecting old ones," with an accompanying shift on social safety nets.
Service industries had to be opened up to competition and productivity had to rise. "Competitive and contestable markets for goods and services, including financial services, are crucial for economic growth."
Stauss-Khan said: "We see the benefits of these reforms clearly. But we must also recognise that people are hesitant about structural reform. Policymakers cannot dictate to people on this."
Reforms could take different paths in different countries, and a consensus was needed, as had been achieved with succes in Denmark and The Netherlands. (AFP)
Europe must limit crisis damage: IMF