Euro zone having first big test - OECD

THE SEVERE recession and the sovereign debt crisis have been the first major “test to the resilience” of the euro zone in its decade-long history, according to the Organisation for Economic Co-operation and Development (OECD).

The Paris-based think-tank, whose members comprise 34 of the world’s highest income countries, believes the “muted” recovery of the euro zone economy will continue, but even that forecast is subject to risks.

The muted nature of economic growth is attributed to a range of factors, including heavily indebted households which are increasing savings and curbing their consumption, and the unwinding of imbalances within the bloc.

The effects of adjustments will be greatest in the weaker peripheral countries where either private or public sectors over-expanded.

“Adjustment will be a difficult and prolonged process in some deficit countries, particularly where prices and wages need to adjust to help shift resources from domestically focused sectors that grew too big during the boom years.”

Inflation is expected to remain subdued, owing to excess productive capacity, which the OECD believes will “remain high for some time”. It therefore anticipates the need for the European Central Bank to tighten monetary policy only in the “medium term”.

The OECD is supportive of EU and euro zone-wide changes to economic policy-making structures aimed at preventing the build-up of future imbalances and bubbles, such as, for example, Ireland’s property bubble.

It suggests that “surveillance of country-level economic, fiscal and financial imbalances by EU institutions should be stepped up”.

Remonstrating with how public finances have been managed in some countries, the OECD says many euro area governments did not do what was necessary to cut public debt levels to sustainable levels when economic growth was solid in the period before the financial crisis.

It says that “prolonged fiscal consolidation and reforms will be needed to bring debt to a more prudent level, increase the ability to withstand future shocks and to prepare for future ageing costs”.

This should include sticks as well as carrots, according to the think-tank. It says that “a range of sanctions, including financial penalties, should be applied quasi-automatically early in the surveillance process”.

It also advocates – as it has long done – liberalisation of labour markets in those countries where rigidities have kept unemployment persistently high. The report says: “Stabilisation would be facilitated by structural policies that help economic adjustment, including ensuring that wage setting mechanisms work well.”

The report lauds measures taken to put in place much more wide-ranging financial sector supervisory structures.

It also believes that removing obstacles to integration of the financial services industry on a euro zone-wide basis would enhance stability.

In a separate release yesterday, the OECD’s monthly leading indicator series – a forward looking survey-based indicator – pointed to a stable rate of future economic expansion in the euro zone.