The global economy is facing a crisis of confidence worsened by “policy indecision and political dysfunction,” according to Christine Lagarde, managing director of the International Monetary Fund.

Speaking in Washington, where the fund’s annual meetings are due to be held next week, Ms Lagarde said that short-term pressures on the balance sheets of European banks and US households risked creating a “vicious circle” of declining confidence.

Ms Lagarde praised last week’s stimulus proposal by President Barack Obama and the recent joint statement of support for Greece by Angela Merkel, German chancellor, and Nicolas Sarkozy, French president. But she added that she was “not backing away” from controversial comments she made last month that European banks needed more capital to support their balance sheets. She reiterated that the US also needed to do more to consolidate its long-term fiscal position, while setting short-term fiscal policy to boost demand.