The OECD’s latest economic outlook provides a very nice summary of global events:
“The recovery in the OECD area has now slowed to a crawl, notwithstanding a short-lived rebound from the restoration of global supply chains disrupted by the Japanese earthquake and its aftermath. Emerging market output growth has also continued to soften, reflecting the impact of past domestic monetary policy tightening, sluggish external demand and high inflation. Against this background, the protracted fiscal-policy discussions in the United States and the deepening euro area crisis have highlighted the role of destabilising events and policies as well as the reduced political and economic scope for macroeconomic policies to cushion economies against further adverse shocks. In turn, this has heightened risk awareness and uncertainty, with a corresponding drop in confidence, both in financial markets and in the non-financial private sector. Lower confidence will weigh on the global economy in the coming quarters.
Decisive policies must be urgently put in place to stop the euro area sovereign debt crisis from spreading and to put weakening global activity back on track, says the OECD’s latest Economic Outlook.
The euro area crisis remains the key risk to the world economy, the Outlook says. Concerns about sovereign debt sustainability are becoming increasingly widespread. If not addressed, recent contagion to countries thought to have relatively solid public finances could massively escalate economic disruption. Pressures on bank funding and balance sheets increase the risk of a credit crunch.
Another serious downside risk is that no action would be agreed to offset the large degree of fiscal tightening implied by current law in the United States. This could tip the economy into a recession that monetary policy could do little to counter.
“Prospects only improve if decisive action is taken quickly,” said OECD Chief Economist Pier Carlo Padoan. “In the euro area, the risk of contagion needs to be stemmed through a substantial increase in the capacity of the European Financial Stability Fund, together with a greater ability to call on the European Central Bank’s balance sheet. Much greater firepower must be accompanied by governance reforms to offset the risk of moral hazard,” he said.
Improved prospects would also depend on the enactment of a credible medium-term fiscal programme in the United States.
Read the full report here.