Source: OECD

The economic recovery now spreading across OECD countries is still too timid to halt the continuing rise in unemployment, according to the OECD’s latest Economic Outlook.

The jobless rate is expected to peak in the first half of 2010 in the US, but it may not be until 2011 that unemployment begins to fall in the Eurozone.

The report says the recovery is tepid because economic activity is being held back by households and businesses repairing their finances and reducing their debts. With a subdued recovery and substantial spare capacity, inflation is projected to continue to fall well into 2010.

On Ireland, the OECD said: "The budget deficit has swelled and public indebtedness has increased sharply. Substantial fiscal consolidation measures are already in place, but more will be needed over an extended period, which will require both further increases in revenues and cuts in public expenditure. With NAMA (the National Asset Management Agency), the government seeks to restore the banking system to health by recognising and dealing swiftly with losses, thus contributing to the recovery. This should be implemented along with the necessary risk–sharing mechanisms to protect the taxpayer."

SEE: Finfacts article, Nov 04, 2009: OECD’s Economic Survey of Ireland: Lenihan says report should be "compulsory reading"

Country summaries

China is leading the global recovery, helped by its limited direct exposure to the financial crisis and by a massive stimulus package.

The OECD says the US is recovering with the help of government stimulus measures, a rebound in world trade underpinned by increasing demand from large emerging-market economies, stockbuilding by businesses and stabilisation of the housing market. US gross domestic product (GDP) is expected to grow by 2.5% in 2010 and a further 2.8% in 2011.  

The Paris-based think-tank for governments, says the Eurozone activity will benefit from the same growth drivers as the US, but work-sharing schemes and other factors which have helped maintain many jobs during the crisis may also weaken the rate of job creation over the coming months. As a result, household confidence is likely to remain weak which could sap the strength of the recovery. The Eurozone economy is projected to grow next year by 0.9% and by 1.7% in 2011.

Japan should benefit from strong growth in the rest of Asia, but weak domestic demand will continue to limit activity. Deflation is expected to linger. The economy is expected to grow by 1.8% and 2.0% in 2010 and 2011 respectively.

“The good news is that the recovery  -- albeit a weak one  - - is underway,” said OECD Secretary-General Angel Gurría. But he added, “With millions of jobs lost and public budgets under strain, governments will have to tread carefully in the months ahead. Removing stimulus measures is imperative but such action has to be carried out gradually to avoid undermining the recovery.”

Jorgen Elmeskov, acting Chief Economist of the OECD said, “Unprecedented policy efforts appear to have succeeded in limiting the severity of the downturn and fostering a recovery to a degree that was largely unexpected even six months ago. “ He added: “It is now time to plan the exit strategy from the crisis policies, even if its implementation will be progressive.”

Elmeskov said government budgets had suffered badly from the crisis. The gross debt of most OECD countries could be larger than their GDP by 2011. Action to bring public finances under control will need to be substantial in most countries and drastic in some. But he added that spending cuts or tax increases should not be carried out at a pace or in areas that would weaken the recovery.

“Radical policy action will be required in the years to come to restore sound macroeconomic balance, healthy growth and low unemployment, “said Elmeskov.“Only when that has happened will the crisis have been fully overcome.” 

The OECD says international imbalances, notably the US deficit and the China surplus, have narrowed appreciably during the downturn. The projections imply that this adjustment has now run its course. With imbalances remaining at levels that would have been unprecedented just a few years ago, the risk of disorderly exchange rate adjustment cannot be excluded. This underlines the importance of international efforts, recently given impetus in the context of G20, to ensure a sustainable international growth pattern.

Overall the risks around the projection may be balanced but the same may not be the case for their consequences. With inflation being low to begin with and set to fall further in most countries, the fall-out from downside risk could be much worse. Japan’s experience has shown that it is more difficult to exit than to enter deflation and that deflation makes it much harder for policy to respond to adverse shocks.

The OECD says these are the rather inauspicious conditions under which governments and central banks have to consider when and how rapidly to roll back many of the measures taken in response to the crisis. Yet preparing exit strategies cannot be put off. Many of the interventions, while appropriate during the crisis, would be harmful if they stayed in place for too long. Preparing and communicating well articulated exit strategies will increase confidence that there is a way out. That in itself will allow for greater flexibility in the implementation of the strategy. Spelling out exit strategies is also useful because many of the policies that will form part of such strategies can be expected to have international spillovers, calling for various degrees of co-ordination across countries ranging from ex ante information sharing to collective policy approaches. Against this background the organisation says it is regrettable that so few exit strategies have so far been articulated - - with, for example, less than half of OECD countries having announced medium-term fiscal consolidation programmes with a clear description of the instruments to achieve the final target.

The think-tank says conventional monetary policy clearly has to reflect domestic economic circumstances and some countries with incipient upward pressure on asset and consumer prices have indeed already begun tightening. But, on the projections in the Outlook, for the majority of OECD countries monetary policy will need to move slowly. With inflation clearly below policy objectives, policy interest rates should only be back to neutrality by the time inflationary pressures begin to be felt. The implied constellation of interest rates across countries could result in capital movements and pressure on asset prices in countries that are ahead in the cycle. Similarly, easy monetary conditions in the majority of OECD countries could risk spilling over into unjustified asset price increases. While asset price developments are a factor that needs to be taken into account by monetary policy, in general other instruments are able to influence these prices more directly and effectively.