OECD Economic Outlook – Vol. 2009 No. 86 (Jan 2010)

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Growth in the OECD area has resumed after the most virulent recession in decades. The recovery is driven by exceptionally strong demand-supporting policy measures, public interventions in financial markets, a strong pick-up in demand in the non-OECD area and a positive contribution from inventory adjustment. Notwithstanding the support to growth in the coming two years from recent and assumed future improvements in financial conditions, the continued need to strengthen financial institutions, on-going private sector balance sheet adjustment and waning macroeconomic policy support are likely to imply a moderate recovery (Table below). Area-wide unemployment is set to continue to rise well into2010 and to fall only modestly in2011 from its peak of over 9% of the labour force. The exceptional slack in the economy will push down underlying inflation further to very low levels in several countries, though only a few will experience falling price levels.

The uncertainty surrounding this projection is very high, but the risks are broadly balanced. Financial conditions could continue to improve faster and more extensively than assumed, setting in motion a positive feedback loop: better economic prospects and stronger business investment driven by better financial conditions reducing concerns about the health of financial institutions, in turn improving financial conditions, and thereby growth, still further. On the other hand, financial conditions could worsen abruptly, for example, if a large financial institution were to get into difficulty. Unemployment also represents a negative risk to the outlook, as its continued increase may depress household expenditure and negatively affect financial institutions to a greater extent than anticipated. While risks may be roughly balanced, their consequences need not be. With inflation being very low in some countries, a negative shock could push such economies into deflationary territory from which it is more difficult to exit.

In this environment, it will be a challenge to start unwinding crisis-induced policies in an orderly and coherent way. Key issues include the timing, pace and modalities of withdrawing extraordinary interventions. Other issues include elaborating strategies to move towards fiscal sustainability, ensuring financial stabilisation while phasing out crisis measures, putting in place an improved financial regulatory framework and strengthening the growth potential of the economy.