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Economy : Governments must balance recovery with fiscal consolidation

Wed, 11/03/2010 - 4:24am
OECD

  Watch the webcast of the press conference  

The pace of the global economy recovery has slowed since earlier this year while public debt in most OECD countries is set to reach all-time highs,  according to an OECD economic assessment presented ahead of the G20 Summit in Seoul. 

With support from fiscal stimulus fading, output and trade have softened. Average GDP growth across OECD countries is expected to be between 2 1/2 to 3 per cent this year,  between 2 and 2 1/2 in 2011 and between 2 1/2 and 3 in 2012. Activity is projected to vary widely across countries, particularly within the euro area. The US is expected to gain considerable momentum in 2012, while the Japanese recovery is expected to lose some steam. In many emerging market economies growth is continuing robustly, although at a slightly slower pace than earlier in the recovery.

The crisis has pushed public deficits and debt to unsustainable levels.

“Simply stabilizing debt relative to GDP in most countries will require a historical consolidation effort of anywhere from 6 to 9% of GDP, said OECD Secretary-General Angel Gurría. “But in fact even more is needed to bring debt back to sustainable levels.”

Specific budgetary rules and the creation of independent fiscal watchdogs can help ensure that essential consolidation measures are also credible, the OECD says. Governments should also seek to strengthen the cost-effectiveness of expenditures that enhance growth, in areas such as health care, education, innovation and infrastructure development.

The OECD says the challenge for monetary authorities will be to exit the exceptional stimulus without exacerbating the fragility of financial markets.

Because of weak growth in the US and euro area, and provided that inflation expectations remain well anchored, the normalisation of interest rates should only proceed in earnest from the first half of 2012, at a pace that allows monetary policy to remain accomodating.

If growth turns out to be weaker than projected, the normalisation of interest rates should be delayed further, the OECD says. Similarly, if deflation persists in Japan, rates could remain at current low levels throughout 2011 and 2012, and further exceptional easing should be implemented to give stimulus to the economy.

Continued monetary ease in many advanced economies prompts capital flows to emerging economies where they risk creating asset bubbles while putting upward pressure on their exchange rates. The recent unilateral interventions in foreign exchange markets and the resulting volatility could prompt  protectionist responses. Better, says the OECD, is to reach a common understanding  on how global imbalances are to be reduced.

Indeed, exchange rate adjustment cannot do the whole job of rebalancing. Structural reforms, such as the strengthening of social safety nets and the development of financial markets in emerging economies, should be employed to reduce their  savings and dependence on financial markets in advanced economies. The OECD sees structural reform s, such as the liberalisation of product markets , also as crucial to recover the output losses associated with the crisis and to help put public finances back on a sustainable path.

The crisis leaves a legacy of high unemployment, which risks becoming  long-lasting. Again, structural reforms, such as the reduction of excessively high taxes on labour, are needed to address this problem.

The task of policy makers is to move from crisis mitigation towards rebuilding confidence and stability. All the main strands of economic policy - fiscal, structural, financial and monetary -  need to contribute in a coherent and consistent manner, says the OECD.

>> Read the speech by the Secretary-General, Angel Gurría

>> Read the presentation by the OECD Chief Economist, Pier Carlo Padoan.

For further information, journalists are invited to contact the OECD’s Media relations division (tel: 33 1 45 24 97 00 or email news.contact@oecd.org) or visit http://www.oecd.org/oecdEconomicOutlook

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