Hours before the US Federal Reserve kicked off its second round of easing in two years, the Organization for Economic Cooperation and Development cut its world economic forecasts for next year, saying the world economic recovery has slowed.
And joining the OECD in cutting its outlook was the International Monetary Fund which dropped its expectations for world economic growth this year and next to 3% to 4%, but also praised the Fed’s move.
The OECD"s cuts for the world’s most developed economies are sharp for 2011 in particular, down to as low as 2% from 2.8% in the June statement.
The IMF’s new range of 3 to 4% is down from 4.8% for this year and 4.2% for 2011.
And the OECD warned that because of the fragility of the recoveries in Europe and the US (and the lack of any inflationary momentum), those countries should hold off "normalising" interest rates (i.e. starting to increase them back towards previous levels) until the first half of 2012, or in 18 months time.
All economic forecasts from the likes of the IMF and World Bank for next year have lower growth rates pencilled in to take account of the ending of government stimulus spending in many economies and the early impact of austerity measures in some economies, especially in Europe.
But the US and Japan in particular are in the midst of unprecedented spending by their respective central banks, and in the case of Japan, more stimulus from the central government.
America on the other hand won’t be spending any more money via the federal government after the mid term elections this week were won by the Republicans and the hardline anti-spending Tea Party.
Now America will have to depend on the Fed to maintain some momentum in the economy through its stimulus, while hoping that it can start prodding business to spend more, consumers to spend and employers to create jobs.
It will be a tall order.
America’s problems cannot be solved by just spending more money. Cuts have to be made in government spending, especially at a federal level.
Exports won’t be stimulated to create more jobs if the rest of the world is starting to slow faster than previously forecast.
Unemployment at 9.6% will start falling, slowly over the next year, but not fast enough to start creating net new jobs (i.e. excess of the natural growth in the population, which is between 125,000 and 150,000 jobs every month).
That’s why $US600 billion in new purchases and another $US300 billion or so in reinvestment won’t have much of an impact at all if the current low interest rate hasn’t helped or the previous $US1.7 trillion in spending from the Fed. Why would a small amount have a dramatic and immediate impact?
The OECD said in its latest statement that the global economic crisis has brought “public deficits and debt to unsustainable levels” which is what they are in countries like the US, Japan, the UK and parts of Europe.
“Simply stabilizing debt relative to GDP in most countries will require a historical consolidation effort of anywhere from 6% to 9% of GDP, said OECD Secretary-General Angel Gurría. “But in fact even more is needed to bring debt back to sustainable levels.”
The group (which now covers 33 of the world’s most developed economies) forecast 2010 growth for its members at between 2.5% and 3% – a wider range than in its previous forecast of 2.7% in June.
It also lowered its growth forecast for next year to 2% to 2.5%, down from 2.8%, a sizeable cut.
The OECD said that, "Fiscal stimulus fading, output and trade have softened. Average GDP growth across OECD countries is expected to be between 2 1/2 to 3 per cent this year, between 2 and 2 1/2 in 2011 and between 2 1/2 and 3 in 2012.
"Activity is projected to vary widely across countries, particularly within the euro area.
"The US is expected to gain considerable momentum in 2012, while the Japanese recovery is expected to lose some steam.
"In many emerging market economies growth is continuing robustly, although at a slightly slower pace than earlier in the recovery.
"Specific budgetary rules and the creation of independent fiscal watchdogs can help ensure that essential consolidation measures are also credible," the OECD says.
The OECD said the challenge for monetary authorities will be to exit the exceptional stimulus without exacerbating the fragility of financial markets.
"Because of weak growth in the US and euro area, and provided that inflation expectations remain well anchored, the normalisation of interest rates should only proceed in earnest from the first half of 2012, at a pace that allows monetary policy to remain accommodating."
And if growth turns out to be weaker than projected, this normalisation of interest rates should be delayed further.
"Similarly, if deflation persists in Japan, rates could remain at current low levels throughout 2011 and 2012, and further exceptional easing should be implemented to give stimulus to the economy," the OECD said.
No mention of deflation in the US, but it was one of the reasons why the Fed decided to go for another round of spending via buying government securities. US inflation is less than 1% on an underlying basis and it’s continuing to ease. US real final demand in the third quarter was just 0.6% annual.
So no real strength in demand in the economy (ignore the stuff about business investment and consumption being solid) and no real inflation:
