The euro zone crisis is now one step away from plunging advanced economies into an abyss of recession and even depression, with waves of bankruptcies and wealth destruction in Europe, the OECD warned today.
It said the euro zone is already in slight recession and the credibility of governments to keep it balanced on a high wire has been stretched to the limit: one false step now could tip the US, Japan and advanced economies into a new grim landscape.
Excessively tight fiscal policy is sending the US economy towards stagnation, the OECD warned a week after failure of congressional efforts to broker a deal on spending cuts and stimulus measures.
"The euro area crisis represents the key risk to the world economy at present," the OECD said in an unusually stark outlook report. "A large negative event would... most likely send the OECD area as a whole into recession," it added.
Even if policymakers manage to avoid the worst, the euro zone is in for a brief recession and the US for a period of slow growth, with emerging countries also hit.
China will slow but still show strong growth with moderate inflation.
But the OECD, forecasting OECD-area growth of 1.9% this year and 1.6% next year, said that if US fiscal policy were eased US growth would be 1.7% in 2011 and 2% in 2012.
The euro zone was set for growth of 1.6% this year and next year just 0.2%, the OECD said, but also stressed there was still time for decisive action by policymakers to shore up stricken credibility and avert a far worse outlook.
The European Central Bank should buy up devalued government debt bonds in huge quantities and interest rates must fall, the OECD said, taking the opposite line to Germany which has so far rejected extra bond purchases, arguing that the priority is for countries in trouble to reform their economies.
The OECD estimated that the euro zone, in order to avert the worst, might need to take on a sizable portion of the Italian, Spanish and Belgian debt worth around €3 trillion, but this would still only represent about a third of the annual output of the currency bloc.
The Organisation for Economic Cooperation and Development, a policy forum for 34 most advanced economies, forecast that the Japanese economy was set to shrink by 0.3% this year, rebounding to 2% growth in 2012.
But a significant worsening of the euro zone debt crisis would push the single currency area into recession of over 2% for the next two years. The US and Japanese economies would also be tipped into recession.
There would be intense pressure for some countries to abandon the euro, which the OECD warned would amplify the crisis and trigger "massive wealth destruction, bankruptcies and a collapse in confidence in European integration."
The OECD, referring openly to the possibility of a country or countries leaving the euro zone, said that more middle-way efforts at "muddling" through would leave the euro zone and world economies in the doldrums for years.
In its baseline scenario, the OECD now expects that after a brief recession the euro zone will manage 0.2% growth next year instead of its previous forecast of a 2% growth. For 2013 it expects growth of 1.4%.
For the US, it expects 2% growth next year instead of 3.1%, with a pick up to 2.5% in 2013. Japan should see growth rebound to 2% next year from a contraction of 0.3% this year owing to the earthquake and tsunami disasters.
Growth in emerging powerhouse China would slow to 9.3% this year from 10.4% last year. A slowdown in world trade will brake growth to 8.5% in 2012 before it climbs to 9.5% in 2013.
In the US, if the automatic cuts agreed in an August budget deal came into force and tax cuts were allowed to expire "the likely outcome would be that the US economy would move close to recession in 2012 and experience only weak growth in 2013," the OECD warned.
One or more countries leaving the euro "would most likely result in a deep depression in both the exiting and remaining euro area countries as well as in the world economy," the report said.
A credible containment of the EU debt crisis would require a significant boost to the euro zone bail-out fund and "together with, or including, greater use of the ECB balance sheet," the OECD said.
OECD warns of slower Irish growth next year
The OECD is forecasting that Irish GDP will rise by 1.2% this year, with growth slowing to 1% next year as Ireland's main export markets weaken.
Earlier this month, the Government lowered its forecast for GDP to growth next year to 1.6%.
The OECD expects an unemployment rate of 14.1% next year, unchanged from this year, though it says the rate will fall to 13.7% in 2013.
