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A very cold pail of water

Nov. 28, 2011

We are concerned that policy-makers fail to see the urgency of taking decisive action to tackle the real and growing risks to the global economy.” –Pier Carlo Padoan, deputy secretary-general and chief economist, Organization for Economic Co-operation and Development (OECD)

Economists, by the very nature of their work, can’t afford to be too optimistic in their outlook; for a rosy picture of the future often leads to the kinds of “irrational exuberance” that helps get us in messes like the Great Recession. Thus, from the outset, most expect economists to be – at the very least – conservative in their outlook for the future.

Yet the most recent global economic outlook released this week by Pier Carlo Padoan (at right), deputy secretary-general and chief economist for Organization for Economic Co-operation and Development (OECD) certainly paints a far darker and more dangerous picture than ones that have come before.

“The global economy has deteriorated significantly since our [OECD’s] previous economic outlook; advanced economies are slowing down and the Euro area appears to be in a mild recession,” he noted in a press briefing released today from the OECD’s headquarters in Paris, France.

“Concerns about sovereign debt sustainability in the European monetary union are becoming increasingly widespread [and] recent contagion to countries thought to have relatively solid public finances could massively escalate economic disruption if not addressed,” he added. “Unemployment remains very high in many OECD economies and, ominously, long-term unemployment is becoming increasingly common.”

While what Padoan dubs as “emerging economies” are still growing at a healthy pace, their growth rates are starting to moderate. “In these countries falls in commodity prices and the slower global growth have started to mitigate inflationary pressures,” he pointed out. “More recently, international trade growth has weakened significantly.”

Thus, Padoan stressed, “contrary to what was expected earlier this year, the global economy is not out of the woods.”

The OECD’s most recent global economic “baseline” outlook assumes that policy-makers in Europe and the U.S., among others, take sufficient action to avoid disorderly sovereign defaults, a sharp credit contraction, systemic bank failures and excessive fiscal tightening.

“We are concerned that policy-makers fail to see the urgency of taking decisive action to tackle the real and growing risks to the global economy,” Padoan noted. “We see the U.S. [economic] growth recovering only slowly, the Euro area entering into mild recession and Japan growing faster because of reconstruction. But this boost [in Japan] is temporary and will fade away.”

The OECD predicts that U.S. gross domestic product [GDP] should rise by 2% in 2012 and by a further 2.5% in 2013, after an expected expansion of 1.7% this year. Euro area growth is forecast to slow down from 1.6% this year to 0.2% next year, before picking up to 1.4% in 2013. In Japan, GDP is expected to expand by 2% in 2012 and 1.6% in 2013, following a contraction of 0.3% in 2011, which reflects the impact of the earthquake and tsunami and subsequent reconstruction activity.

More broadly, OECD projected that Chinese economic growth will slow to 8.5% in 2012 from 9.3% this year, before climbing back to 9.5% in 2013. Weaker activity in China and other emerging-market economies together with modest falls in commodity prices should put inflation in these countries on a downward trend, allowing some easing of monetary policy, the group noted.

Under this “baseline” scenario, weak activity, low levels of inflation and predominantly downside risks should trigger strongly accommodative monetary policy in OECD countries. Central banks should provide ample liquidity to calm tensions in financial markets and prepare contingency plans that could be implemented swiftly if needed, noted Padoan.

He stressed, however, that many factors underpin this assessment – and if those factors change, things could get worse in a hurry.

“The headwinds of deleveraging in the financial and government sectors remain with us,” Padoan said. “Likewise, imbalances within the Euro area, which reflect deep-seated fiscal, financial and structural problems, have not been adequately resolved. Above all, confidence has dropped sharply as skepticism has grown that euro area policy makers can deal effectively with the key challenges they face.”

In particular, he cautioned, serious downside risks remain in the Euro area linked to the possibility of a sovereign default and its cross-border effects on creditors, and loss of confidence in sovereign debt markets and the monetary union itself. 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.

“More than usual, world economic prospects depend on events, the nature and timing of which are highly uncertain,” Padoan explained. “These projections portray a scenario that rests on the assumptions that monetary policy remains very supportive – and, in some places, becomes more so – that sovereign debt and banking sector problems in the euro area are contained and that excessive fiscal tightening will be avoided.”

From the second half of 2012, confidence is assumed to recover gradually as it becomes clearer that worst-case outcomes have been avoided, OECD predicts, with near-term output growth subdued in the OECD economies and at below-trend rates in the major emerging-market economies.

In some economies, especially the Euro area, a mild recession is projected in the near term, Padoan said, while unemployment in the OECD area is also projected to remain high for an extended period, with the jobless rate staying at around 8% through the next two years.

Not a pleasant outlook by any means – indeed, in some respects, it’s rather daunting; especially in terms of the impact on the freight markets. Then again, if “decisive action is taken quickly,” in Padoan’s words, the worst could be largely avoided. We’ll just have to wait and see if such action is in the offing.

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