In its twice-yearly report on the global economic outlook, the OECD lowered its growth forecasts for the world's largest economies, and said the euro zone has fallen into recession. It also warned that the bloc's debt crisis, now affecting countries previously seen as safe havens, could "massively escalate economic disruption if not addressed."
"Contrary to what was expected earlier this year, the global economy is not out of the woods," Chief Economist Pier Carlo Padoan wrote in his forward to the report. "Above all, confidence has dropped sharply as skepticism has grown that euro-area policy makers can deal effectively with the key challenges they face."
The Paris-based think tank cut its forecast for economic growth in its 34 members to 1.9% this year and 1.6% in 2012, from 2.3% and 2.8% in May. It expects the euro zone's economy to shrink by 1% at an annualized rate in the last quarter of this year and by 0.4% in the first three months of 2012. The 17-country bloc's economy will only grow by 0.2% in 2012, the OECD said.
"The euro zone must urgently take stronger measures," Padoan said in an interview with Dow Jones Newswires. "The ECB should buy bonds and set a limit to yields, or a floor to bond value, so that markets know there's a counter party ready to trade at that level."
To stop the contagion, policy makers need to secure "credible and substantial increases" in the capacity of the European Financial Stability Fund, the euro zone's bailout vehicle, together with a greater use of the ECB's balance sheet, Padoan said.
The euro zone's crisis passed another milestone last week, as the German government managed to sell barely half the bonds it wanted to in an auction, a sign that the currency area's troubles are affecting its strongest economies.
But there is little sign that euro-zone governments will agree on the measures the OECD believes are needed. Germany opposes France's plan to give the ECB a greater role in restoring calm to the bond markets. The ECB currently buys limited amounts of government bonds on the open market to stem the rise in borrowing costs.
The OECD warned that possible but unlikely outcomes such as a disorderly default on government debt, or a break up of the currency area would have serious consequences around the world.
"A large negative event would, however, most likely send the OECD area as a whole into recession, with marked declines in activity in the United States and Japan, and prolong and deepen the recession in the euro area," Padoan wrote. "The emerging market economies would not be immune, with global trade volumes falling strongly, and the value of their international asset holdings being hit by weaker financial asset prices."
Concerns about deteriorating public finances are also growing outside Europe, after lawmakers heading a U.S. congressional supercommittee announced last week they had failed to reach a deal to rein in a rising budget deficit, increasing the risk of draconian cuts to domestic programs and the military come January 2013.
"Another serious downside risk is that no action will be agreed upon to counter the pre-programmed fiscal tightening in the U.S., which could tip the economy into a recession that monetary policy can do little to counter," Padoan said.
The OECD expects the world's largest economy to grow by 2% in 2012, having forecast an expansion of 3.1% in May. It expects growth to pick up again to 2.5% in 2013.
The economic slowdown is also affecting trade, the OECD warned, as it cut its prediction for global trade growth to 6.7% for this year and 4.8% for 2012, less than the 8.1% and the 8.4% increase previously expected.
"The present situation is worse than in 2009," Padoan said. "Trade was the driver of economic growth after the 2008 financial crisis, but now we're seeing risks of protectionism."
The OECD said developing economies will continue to make a "substantial" contribution to global economic growth.
"Emerging economies are still growing at a healthy pace, but their growth rates are also moderating," Padoan wrote. "In these countries falls in commodity prices and the slower global growth have started to mitigate inflationary pressures."
However, the OECD said that in some cases, an immediate easing of monetary polices may not be appropriate.
"In deciding whether, when and how rapidly to ease, central banks need to take into account that inflation in some cases starts from a level well above implicit or explicit targets," the OECD said.
The OECD said China would be better able to respond to slower growth if the yuan were allowed to appreciate.
"Without such currency policy, domestic monetary policy instruments... have to be kept at comparatively more restrictive levels to keep inflation on track," the OECD said. "Such a strategy involves a risk of an excessive economic slowdown."
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