Doom and gloom, continued

A non-fiscal cliff earlier today

After Monday’s post about how bad things could get, I thought an article on the OECD’s interim global economic outlook released today would cheer you up. It won’t. English prepositions being what they are, “cheer you down” doesn’t exist, but if it did, down you would be cheered. A quick glance at the early reactions from the international media gives you the flavour, even if you don’t speak the languages: Rezession, récession, recessione. The OECD projects that the euro area’s three largest economies – Germany, France and Italy – will shrink at an annualised rate of 1 percent on average during the third quarter of this year and at 0.7 percent in the fourth.

The euro area crisis is dragging down the rest of the world economy through its impacts on trade and business and consumer confidence. The outlook thinks that “durable” changes are taking place in the geographical composition of global imbalances, with the euro area trade surplus rising on soft domestic demand and fiscal consolidation. China’s exports to the euro area are being hit hard. This may affect China’s ability to invest in the US in the longer term, although that aspect is beyond the scope of an interim outlook. In the US itself, an increasing non-oil deficit is offset by an improving oil balance. This is another area where longer-term developments will be interesting. Oil production from deepwater sites and unconventional sources such as oil sands or the Arctic will grow, and most of the potential fields are outside the Middle East. The Japanese surplus is falling because of rising energy imports and sluggish exports. Business investment is holding up, but mainly due to post-disaster reconstruction.

Could it get even worse? Yes it could: “Risks to the outlook remain significant”. Apart from the euro area crisis, the report mentions the US heading for a “fiscal cliff”. Even if you’ve never heard that expression, you probably suspect that it’s the kind of cliff you fall, jump or are pushed off. The outlook explains that current legislation implies an extremely sharp fiscal tightening in 2013 (the fiscal cliff) that would probably push the US economy into recession. It then urges the political parties to agree on detailed medium-term consolidation plans to avoid this. Perhaps one of our American readers could tell us what the chances are of the parties doing this.

Fiscal policy poses problems elsewhere too. Rigour, austerity, tightening or whatever it’s called is a medium-term policy, but it’s acting as a drag on short-term economic activity. Some countries may actually be caught in a negative feedback loop whereby activity is weaker than expected when planning the budget, so less tax comes in and there is overspending and then the need for more consolidation, which acts as a drag…

The outlook suggests actions to address feedback loops that undermine the euro’s stability. Speculation that Greece or others might leave the euro are pushing up sovereign bond yields, making it more expensive for some governments to borrow, further reinforcing fears of a break-up. The OECD argues that exit fears could be soothed if the ECB intervened in bond markets to keep spreads (the different interest rates paid on sovereign debt of one country compared to another) within ranges justified by the fundamental economic conditions.

And in a move that will no doubt enrage euro sceptics, the Organisation also calls for further progress towards banking union to increase the availability of public funds to recapitalise banks, along with full recognition of non-performing loans enforced by common supervision.

This just in. Mario Draghi, the European Central Bank’s president has announced a plan whereby the ECB will buy unlimited quantities of government bonds to help countries facing high interest rates. Critics say it will discourage governments’ efforts to balance the books and that it would fuel inflation. That’s not the opinion of OECD Secretary-General Angel Gurría who backed such a move a month ago. “Speculators will lose their bet against the euro, because the ECB will then pull out all the stops,” he told the Neue Osnabruecker Zeitung, adding that he saw no risk of inflation in the short term.

So far, the announcement has boosted stock markets and helped  Italian and Spanish bonds, so maybe the gloom will not become doom. Watch this space.

Useful links

OECD work on the economic outlook, analysis and forecasts

OECD Sovereign Borrowing Outlook