The recovery reflects the feed-through of earlier improvements in financial conditions, accommodative monetary policies and reduced drag from fiscal policies. But unemployment is set to remain stubbornly high, while growth in large emerging market economies is expected to be relatively subdued by recent standards, and this is likely to exert some drag on the OECD area.
The strengthening recovery in the US should gradually reduce unemployment, while inflation will rise close to target. In Japan, core inflation will remain below target. In the euro area, a muted pick-up will make little dent in joblessness, while ample slack will keep inflation very low. Monetary policy needs to remain very accommodative as a result. In Japan, asset purchases should continue as planned, but be wound down in the US, should unemployment continue to fall and inflation strengthen as projected. While the planned slowing in the pace of fiscal consolidation in the US and the euro area is appropriate given the state of public finances and the economic outlook, a strong fiscal tightening in Japan is necessary to slow public debt accumulation and eventually reduce debt. Structural reforms are critical for exiting the crisis to strengthen growth prospects and debt dynamics, and facilitate global and euro area rebalancing.
The outlook contains sizeable long-standing downside risks. For instance, if the US debt ceiling became binding early in 2014, it could have large adverse effects on the stability and growth; the legislated nominal debt ceiling should therefore be abolished. Tapering (meaning the steady unwinding of US asset purchases) may also cause turbulence when actual tapering takes place, notably in emerging markets though with negative effects on advanced economies too. In the euro area, still weak bank balance sheets, fragile public finances and the uncertain political situation in some vulnerable countries could unsettle financial markets, too, which points to the need for a fully-fledged banking union.
©OECD Observer No 297, Q4 2013