PARIS (MNI) – As the global recovery gains steam, governments
should shift policy gears next year from economic stimulus to fiscal
consolidation, while central banks keep interest rates low well into
2012, the Organization for Economic Cooperation and Development said
Thursday.

“Central banks should move away from close-to-zero rates relatively
early, once recovery looks firm and deflation risks fade, but then wait
until signs of incipient inflation increases begin to emerge before
starting to normalise in earnest,” the OECD said in its Economic
Outlook.

While highlighting the downside risks to the recovery from widening
global imbalances, soaring public debt, wobbly banks and large capital
flows to emerging economies, the OECD is fairly confident that the
looming slowdown in global activity will “prove only temporary.”

“The global economy is continuing to recover, but progress has
become more hesitant,” it said. “With monetary policies remaining
accommodative even as fiscal consolidation becomes widespread, the
present soft patch in output growth is not projected to persist for
long.”

“After the near-term slowdown, global trade growth is expected to
generally remain buoyant through 2011-12, continuing to grow at close to
the pre-crisis rate of 1.7 times world output growth,” it said.

The growth in emerging economies and “more hesitantly” in the
advanced economies should pick up from the start of next year, “provided
that policy stimulus is withdrawn in a gradual manner,” it said.

Nevertheless, “the risks around the forecast remain substantial,
and are deeper on the downside than on the upside,” it warned.

The central theme of the OECD’s policy recommendations is the need
for “rebalancing” — beginning on the fiscal side and then, very
cautiously, on the monetary side as well.

“Rebalancing needs to be implemented gradually but decisively,
leaving no doubt as to the direction the global economy is taking,” said
the OECD’s chief economist, Pier Carlo Padoan, in his introduction to
the report.

“Resolute and collaborative policy action to restore macroeconomic
balance and a renewed commitment to structural reforms will boost
confidence, hasten the exit from the recession and revitalize sustained
growth in living standards worldwide,” he argued.

“In countries that have a choice, the extent and speed of fiscal
consolidation will depend in part on the scope for monetary policy to
offset the adverse near-term effects on demand from fiscal tightening by
reducing or delaying increases in policy interest rates,” the report
said.

Simultaneous fiscal tightening will dampen demand somewhat in the
short term, Padoan acknowledged. “International spillovers are important
and the negative effects on demand would be amplified.”

“However, our judgement…is that, given consolidations now
planned, such adverse consequences would be limited,” he argued. “In the
medium term, spillovers would act in the opposite direction, reinforcing
the positive growth effects of consolidation.”

“The challenge for most monetary authorities will be to exit from
exceptional stimulus in a way consistent with macroeconomic
developments, without exacerbating fragilities in financial markets,”
the OECD said.

Given the negative effects of zero or close-to-zero rates, central
banks, apart from Japan’s, should tighten slightly starting from the
middle of next year, it said. U.S. short-term rates are seen firming
from 0.3% in the first half of next year to 1.2% in early 2012. In the
Eurozone rates would edge up to 1.1% in the second half of 2011.

“The normalization of policy interest rates in the United States
and the euro area should begin in earnest only from the first half of
2012,” the OECD advised. In the U.S., this implies a 100 basis point
rise in short-term rates to a still accommodative level of 2.5% by the
end of 2012. Short-term Eurozone rates are expected to climb more slowly
from 1.4% at the start of 2012 to 2.1% in the final quarter.

“In Japan, against the backdrop of persistent deflation, policy
rates should remain at their current low levels throughout 2011 and
2012, and significant quantitative easing should be implemented to give
stimulus to the economy,” the OECD argued.

“If output growth were to turn out weaker than projected in the
major OECD economies, the normalization of policy interest rates should
be delayed further, and, depending on the duration and extent of
economic weakness, firmer actions might be needed to lower real interest
rates further out in the maturity spectrum via additional quantitative
easing and communications policies.”

Monetary policy can afford to remain accommodative, since ongoing
economic slack “is likely to continue to bear down on inflation for some
time to come,” with productivity gains largely offsetting a moderate
pick-up in wage inflation in the Eurozone, the OECD said, adding that it
saw little risk of “widespread” deflation pressures.

U.S. core inflation is projected to drift down to just below 1%
over the projection period. Deflation is expected to persist in Japan,
“although at a slowly diminishing pace,” it said. Eurozone core
inflation is forecast to edge up towards 1.25% as profit margins widen.

Overall financial conditions are likely to remain “supportive,
although moderating gently towards normal levels as the gradual move
towards normalization of policy rates begins and bond yields rise,” it
said.

The forecasts assume that long-term interest rates “revert
gradually to historical norms over the medium term,” the OECD said.
“However, historical experience suggests that the adjustment could occur
more abruptly. A rapid unanticipated increase in long-term interest
rates could weaken the recovery through its direct effects on
investment.”

As usual, the OECD called for flanking structural reforms to
enhance growth and employment prospects. “Reforms to improve
public-sector productivity, remove barriers to job creation, change the
tax structure and implement pollution-pricing mechanisms would all help
to protect growth and employment and facilitate fiscal consolidation,”
it said.

The economic projections assume unchanged exchange rates from those
prevailing on October 26 and a Brent crude price around $80 per barrel.
Non-oil commodity prices are assumed to stabilize around current levels.

–Paris newsroom +331 4271 5540; e-mail: stephen@marketnews.com

[TOPICS: MI$$$$,M$X$$$,MT$$$$,M$A$$$,M$J$$$,M$X$$$,M$$EC$,M$U$$$,MMUFE$]