OECD: US may be hit harder by EU woes

2011-11-28 12:25

Washington - The US economy may face a graver threat from Europe’s debt crisis than is currently thought, the Organisation for Economic Cooperation and Development (OECD) said in a report warning the recovery could be derailed.
In its latest economic outlook released on Monday, the OECD said the level of uncertainty surrounding the US economy was high and risks were heavily tilted to the downside.

“Negative spillovers from the turmoil in European markets could be greater than expected and have the potential to derail the recovery in activity and renew fears among financially fragile households and businesses,” it said.
So far, analysts and some Federal Reserve officials have played down concerns that the eurozone debt crisis, which has roiled financial markets, will hit the broader economy hard.

One reason they cite is that US exports to the eurozone account for only about 2% of gross domestic product, so the pain from the region’s fiscal crisis will be transmitted mostly through declining stock prices.

The OECD forecast US growth averaging 1.7% this year, picking up to 2.0% in 2012.

In the event of a shock from the debt crisis, the OECD recommends easing fiscal tightening by prolonging extended unemployment benefits and increasing access to income tax credits and food stamps.
“Effective activation measures will be vital to minimise a heightened risk of rising structural unemployment,” the OECD said.

It forecast average US unemployment of 9.0% this year, edging down to 8.9% in 2012.

Fiscal sustainability

The OECD’s recommendation for strengthening so-called automatic stabilisers could get a lukewarm reception from lawmakers when pressure is on to slash ballooning government debt and politicians cannot agree where to make the cuts.
There are concerns that a 2% payroll tax holiday and extended benefits for nearly two million Americans will not be renewed when they expire at the end of next month.

Economists warn that, if that happens, it would place a drag on recovery. Still, the OECD said the United States needed to work hard to secure longer-term fiscal sustainability.
“A credible commitment to fiscal sustainability would aid the recovery by increasing confidence, reducing uncertainty and lowering the risk of disruptive logjams over the federal debt ceiling and possible resulting government shutdowns,” it said.

Even though the Fed had cut its overnight lending rate to near zero and pumped about $2.3 trillion into the economy through asset purchases, the US central bank still has options to support the economy, the OECD said.

“The FOMC (Federal Open Market Committee) decision to keep short-term interest rates at an exceptionally low level through at least mid-2013 was a welcome signal,” it said.

“Further actions to adjust the Fed’s portfolio toward holding longer-dated securities could help ensure that the yield curve does not steepen.”

Fed chairperson Ben Bernanke has said buying more mortgage-backed securities was an option to aid the economy.
The OECD also urged more measures to allow creditworthy households, with home loans worth more than the value of their properties, to reduce their payment burdens by refinancing.

This would reinforce a critical channel for low interest rates to stimulate the economy, it said.
The OECD said financial sector reforms laid out in the Dodd-Frank legislation needed to be implemented without delay as financial institutions would come under even greater stress if downside risks materialised.
“Action to introduce a macroprudential framework would provide confidence that financial stability will be maintained,” it said.