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08 September 2011

OECD says economic growth perspectives weakening as recovery slows


Economic recovery appears to have come close to a halt in the major industrialised economies, with falling household and business confidence affecting both world trade and employment, according to new analysis from the Organisation for Economic Cooperation and Development.

Activity has come close to stagnation

The recovery almost came to a halt in the second quarter in many OECD economies. And downward revisions to earlier published data point to weaker underlying activity economic than had previously been thought. Compared with the May Economic Outlook, growth turned out weaker in the first half of the year both in the United States and the euro area.

Global trade has weakened, global imbalances persist

World trade stagnated in the second quarter, only partly due to disruptions in supply chains after the March 2011 disaster in Japan. Export orders and costs of container shipment have declined. Current account imbalances remain large. The Chinese trade surplus has been widening recently with the effective exchange rate broadly stable. Oil exporting countries again post increases in their external surpluses on the back of high oil prices.

Improvements in labour markets are fading

Hiring intentions have been softening over the summer. In Japan, employment was adversely affected by the March 2011 disaster. High long-term unemployment and weak unemployment outflow rates in some economies point to a risk of high unemployment becoming entrenched. Reforms of structural labour market policies are required to prevent “cyclical” unemployment from becoming structural.

Consumer and business confidence fell in major OECD economies on the back of weak incoming data, gridlock over fiscal policy in United States, the euro area sovereign debt crisis, and growing concern that there is less policy ammunition to offset further weakness.

Risk perception changed

Some elements of financial conditions have clearly deteriorated, whereas others have improved, with the net balance somewhat different across countries. Heightened risk aversion in financial markets is reflected in wide sovereign risk spreads in the euro area, tumbling share prices and increasing yields on higher-risk corporate bonds, but not yet in tighter lending conditions. The fall in long-term government bond yields in some countries, reflecting a flight to safety and a belief that monetary policy will stay accommodative for a longer period, may provide an offset.

Growth likely to stay weak in second half of year

OECD GDP indicator models project quarterly growth in G7 economies excluding Japan to remain less than 1 per cent (annualised) on average in the second half of this year. The United States is set to grow in the range of ½-1 per cent. Growth in Japan is expected to be buoyed by reconstruction, though its effect on growth is expected to fade in the final quarter. Germany and Italy are projected to post one quarter of negative growth. The impact of the sovereign debt woes in Europe and the United States and the associated turbulence in stock markets over the summer have not yet fully fed through into the indicators underpinning the projections. The risk of more negative growth going forward has become higher in some major OECD economies, but a downturn of the magnitude of 2008/09 is not foreseen.

Uncertainty around projections unusually large

Since the onset of the financial crisis, errors in the forecasts presented at the Interim press conferences have been larger than implied by the estimated average error range pre-crisis. In times of high uncertainty, as presently is the case, the average revision from successive updates of the indicator model projections tend to be larger. Uncertainty is currently particularly high for Japan (which reflects the difficulty in assessing the impact of the March 2011 disaster) and the United States.

Multiple sources of risk

Levels of residential construction, business investment and durables consumption are low. Hence, destocking or disinvestment are unlikely sources of further weakness. The unwinding of temporary factors that damped growth in Germany (shutdown of nuclear plants) and France (effects from car scrapping phase-out) in the second quarter may prompt a sharper than projected rebound in activity in the third quarter. Federal budget outcomes have been better than expected so far this year in United States. More generally, stronger fiscal consolidation may have been exerting more drag on activity than anticipated, and it is unclear what repercussions this might have for demand in the near term. The recent decline in oil and other commodity prices has been less than expected on the basis of historical relationships with global demand, adding uncertainty as to how these prices might behave in the near term. A sharp widening in the sovereign yield spreads of Italy and Spain in August prompted the European Central Bank to intervene heavily in government bond markets. The sovereign debt crisis in the euro area could intensify again. Renewed concerns over balance sheet of banks, reflected in CDSs and money market spreads, point to possible further tightening of financial conditions. If money markets freeze up, growth may be adversely affected.

Requirements for monetary policy

Policy rates in most OECD economies should be kept on hold. If in the coming months signs emerge of the weakness enduring or the economy risks relapsing in recession, rates should be lowered where there is scope. Where there is not such scope, other measures could include further central bank interventions in securities markets (even if at diminishing returns) and strong commitments to keep interest rates low over an extended period. Emerging market economies should withdraw monetary tightening if inflation is moving towards target. They should allow appreciation of effective exchange rates in cases where inflation is still high and the trade balance is widening.

Requirements for fiscal and structural policy

The space for fiscal policy to react depends on the state of public finances, the ease at which government debt can be funded, the underlying strength of the economy and the presence of credible medium-term frameworks so as to not undermine confidence. If there are prospects for a long-lasting slowdown in activity, countries that have, or put in place, credible fiscal frameworks are in a better position to react and should do so. Countries with limited fiscal space have restricted scope for fiscal easing and some have to tighten amid cyclical weakness. Growth-friendly structural reforms should be adopted, as these favourably affect public revenues, primary expenditures and debt dynamics, while reducing government borrowing costs via confidence effects. A proper mix of consolidation instruments, including an increase in the pensionable age (raising life-time earnings), can limit adverse effects on, or even stimulate, demand in the short run. A first step to address the euro area debt crisis is to implement the euro area framework decided on 21 July this year. But to stop contagion and restore confidence, the governance of the euro area must be improved and the capitalisation of banks strengthened in view of their exposure to fiscally-distressed euro area countries.

Full report



© OECD


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