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.
Hints of cautious optimism in the latest OECD assessment of the state of the global economy. The organisation expects economic activity in OECD countries to gradually pick up over the coming two years. However, the pace of recovery won’t be the same everywhere, and unemployment will remain high.
Overall, GDP in OECD countries is projected to rise by 2.3% next year and 2.8% in 2012. With an expansion of 2.2% in 2011, growth is forecast to be faster in the United States than in either the Euro area or Japan, which are both tipped for growth of 1.7%. Looking a little further ahead, the US expansion is forecast to rise to 3.1% in 2012, against 2% in the Euro area and 1.3% in Japan.
Despite the relatively upbeat message, the OECD is still strongly concerned about a number of factors that threaten the recovery. Among the most significant are a widening in global imbalances, which helped fuel the crisis in the first place. These could be exacerbated by uneven growth in the OECD area, as well as between the OECD and emerging economies, which are expected to perform even more strongly than the developed OECD countries.
Other potential problems include the possibility of further falls in house prices, especially in the US and the UK, high sovereign debt in some countries and possible abrupt reversals in government bond yields.
Click here for lots more coverage of the latest OECD Economic Outlook, including a webcast of the launch (starting 10am GMT, Thursday 18 November).
Last week, we reported on the latest OECD Economic Outlook. Writing in the New York Times, Paul Krugman was highly critical of the Organisation’s analyses and policy recommendations. Here we summarise Krugman’s argument and the reply by OECD Deputy Secretary-General and Chief Economist Pier-Carlo Padoan.
Krugman argues that the most ominous threat to the still-fragile economic recovery is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain.
He contrasts this with actions taken when the financial crisis first struck, and most of the world’s policy makers responded by cutting interest rates and allowing deficits to rise.
He goes on to say that “The extent to which inflicting economic pain has become the accepted thing was driven home to me by the latest report on the economic outlook from the Organization for Economic Cooperation and Development… what [the OECD] says at any given time virtually defines that moment’s conventional wisdom. And what the OECD is saying right now is that policy makers should stop promoting economic recovery and instead begin raising interest rates and slashing spending.
What’s particularly remarkable about this recommendation is that it seems disconnected not only from the real needs of the world economy, but from the organization’s own economic projections.”
His demonstration is as follows. The OECD declares that interest rates should rise sharply over the next year and a half to head off inflation, but inflation is low and declining, and OECD forecasts show no hint of an inflationary threat.
The reason the OECD wants to raise rates is in case markets start expecting inflation, even though they shouldn’t and currently don’t.
Likewise, although the OECD predicts that high unemployment will persist for years, it asks that governments cancel any further plans for economic stimulus and that they begin fiscal consolidation next year.
Krugman insists that both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because a weaker economy depresses tax receipts, wiping out any gains from governments spending less.
Moreover, the reasons for doing this don’t hold. Investors aren’t worried about the solvency of the US government and interest rates on federal bonds are near historic lows. And “even if markets were worried about U.S. fiscal prospects, spending cuts in the face of a depressed economy would do little to improve those prospects”.
This contrasts with the OECD’s calls for cuts because inadequate consolidation efforts “would risk adverse reactions in financial markets.”
Krugman is worried that this view is spreading, citing the case of “conservative members of the House, invoking the new deficit fears, [who] scaled back a bill extending aid to the long-term unemployed… many American families are about to lose unemployment benefits, health insurance, or both — and as these families are forced to slash spending, they will endanger the jobs of many more.
He concludes by stating that “more and more, conventional wisdom says that the responsible thing is to make the unemployed suffer. And while the benefits from inflicting pain are an illusion, the pain itself will be all too real.”
In reply, Padoan starts by saying that they differ on the strength of the recovery, with the OECD more optimistic than critics of the Outlook. Unemployment will take time to fall to acceptable levels, but this will be underway by 2011. A double-dip recession cannot be ruled out, but is not very likely. The risks of running big fiscal deficits and a zero interest rate monetary policy are rising.
Recent events in Europe are a warning sign and even though the US has the world’s biggest capital market, the risks are shifting. In this unsettled financial environment, governments need to get out ahead of markets, because otherwise they will be hostage to them.
On inflation, he argues that it is not a risk today, but could be in two-years’ time. Monetary policy needs to be forward looking and this means easing up on monetary stimulus in anticipation.
“To be clear, we are not arguing for contractionary policy, but for progressively less stimulus. In fact, stimulus should not be withdrawn completely until the economy returns to full employment. But the process should be started fairly soon, to take into account the well known long and variable monetary policy lags.”
How quickly interest rates should rise depends on many things, especially inflation, inflation expectations and the pace of growth. It also depends on fiscal policy, which influences growth.
“All else equal, if fiscal policy turns out to be tighter than in our projection, then monetary policy should be looser to compensate.”
The OECD Economic Outlook, released on Wednesday morning at the OECD Forum in Paris, projects economic growth for 2010 in the OECD zone of 2.7%. That’s in strong contrast to last year’s contraction of 0.6%.
But there’s substantial variation between regions in the pace of recovery. The United States is projected to see growth of 3.0% in 2010, or double the 1.5% expansion seen for Europe. Japan’s growth rate is projected at 2.7%.
Despite the recovery, unemployment remains high: Over the past two years, about 16 million people joined the ranks of the unemployed in OECD countries. However, the OECD suggests the unemployment rate may now have peaked at just over 8½%.
The OECD sees the economic outlook as “ moderately encouraging”, but, it warns, it could be jeopardized by “significant risks”. Among these are the danger of a sharp downturn in emerging economies like China and India, which are currently helping to drive the global rebound. The OECD is concerned about the potential for overheating in emerging economies, and warns that “a boom-bust scenario cannot be ruled out”.
The OECD is also concerned about the situation in Europe, notably the debt problems of a number of countries in the euro zone. Action taken by European governments and the European Central Bank have gone some way to calming market jitters, but, the OECD warns, “the region’s underlying weaknesses are far from settled”.
Find links to further coverage of the Economic Outlook