Many leading industrialised nations face their worst economic downturn for 25 years, the OECD warned today, forecasting that the US, European and Japanese economies would shrink next year.
Unemployment will rise by eight million, house prices will continue to fall in many countries and there is a risk the financial crisis has further to run, with fragile banks exposed to new bad debts.
'Many OECD economies are in or are on the verge of a protracted recession of a magnitude not experienced since the early 1980s,' said the chief economist of the Organisation for Economic Co-operation and Development, Klaus Schmidt-Hebbel.
On Ireland, the report says economic weakness will persist 'well into 2009' but will recover in 2010. It says budgetary policy should be allowed to boost demand in the near-term. It expects the economy to shrink by 1.8% this year and 1.7% in 2009. This is more optimistic than recent forecasts from other economists.
The Paris-based government-funded economics institute delivered its prognosis in its OECD Economic Outlook report which looked in detail at its 30 rich-country members which account for about 60% of the world economy.
'The number of unemployed in the OECD area could rise by eight million over the next two years,' Schmidt-Hebbel said. The report forecast the jobless rate to rise from 5.5% in early 2008 to 7.25% in 2010.
The economies of all major industrialised countries were forecast to contract in 2009, with the US economy shrinking by 0.9%, the euro zone by 0.6%, Japan by 0.1% and the overall OECD zone by 0.4%.
'The recovery is also more typically more muted following a banking crisis,' the OECD said, adding that many OECD countries would not return to their long-term average growth rates until mid-2010.
The OECD backed the idea of stimulus plans by governments to attenuate the effects of the financial crisis, but also highlighted the impact of debt and stressed that tax and spending plans had to be reversed when growth returned.
'In normal times, monetary rather than fiscal policy would be the instrument of choice for macroeconomic stabilisation. But these are not normal times," said Schmidt-Hebbel, who said central banks should also cut rates further.
The long-term fiscal outlook in the US appears 'very unfavourable' and the country is on course to be 'among the most heavily indebted of OECD countries' in the next decade.
A number of countries have rolled out stimulus packages for their economies in recent weeks, with Britain becoming the latest yesterday with a £20 billion sterling package of tax cuts.
The OECD also said that the European Central Bank will slash its main interest rate to 2% in early 2009 and could go even farther if the situation worsens.
'With inflationary pressures already easing, there is scope for additional monetary stimulus, which should be prompt to minimise the downside risks to activity,' the OECD said.
The OECD forecast that the ECB would cut its main rate from 3.25% currently to 2% 'by next spring, and remain at that level for a year.' However, if the financial or economic situation turned more dire than expected, then 'deeper interest rate reductions could prove necessary in the near term,' it said.
The OECD estimated that inflation would fall in line and even below the ECB's comfort zone, which it defines as a rate of less than but close to 2%.
It forecast that inflation would fall from 3.4% this year to 1.4% in 2009 and 1.3% in 2010 although the rate would reach as low as 1% in the third quarter of 2009.
