The OECD called on EU leaders today (22 May) to ease the pace of austerity, saying aggressive budget cuts to curtail the eurozone's debts threaten to suck the currency area into a downward spiral that could spill over into the global economy.
German-led fiscal austerity policies have so far dominated the European Union's approach to solving Europe's devastating public debt crisis as leaders try to win back investors' confidence. But efforts to reduce deficits have caused the eurozone's economy to stagnate, making it harder to reach EU-mandated targets.
"The risk is increasing of a vicious circle, involving high and rising sovereign indebtedness, weak banking systems, excessive fiscal consolidation and lower growth," said Pier Carlo Padoan, the chief economist of the Organisation for Economic Co-operation and Development.
The drag on growth was evident in the Paris-based think tank's forecast for the 17-nation euro zone, which sees the bloc's economy shrinking 0.1% this year and only growing 0.9% in 2013 – less than half the United States' projected growth next year.
Unemployment is likely to reach a new record of 11.1% of the working population, it said.
"For Spain and other countries, if there are unforeseen drops in economic activity then the fiscal necessary adjustment which ensues should only be done very gradually," Padoan told Reuters in an interview before the report's official release.
Spain, France and the Netherlands will miss their 2013 deadline to cut to 3 percent or less of gross domestic product unless they take action, the European Commission said this month, which could lead to financial sanctions under EU rules.
But Spain's economy, already in recession, is likely to shrink more this year as Madrid tries to implement the deficit cuts, adding to doubts over the country's ability to manage its finances without emergency aid.
According to OECD calculations, efforts to reduce deficits during a downturn are self-defeating because about one-third of the planned cuts are erased by the contraction in the economy.
Italian Prime Minister Mario Monti has won an ally in new French President François Hollande in trying to shift Europe's focus to growth, as well as reining in debts, and Hollande aims to push measures to boost the economy at an EU summit tomorrow (23 May).
Hollande will meet Spanish Prime Minister Mariano Rajoy in Paris hours before the summit in Brussels and the two are likely to discuss steps to stimulate growth and create jobs.
The OECD signalled its support for the kind of growth measures backed by Hollande, Monti and Rajoy.
They include issuing bonds jointly underwritten by all eurozone countries to recapitalise banks, increasing the resources of the European Investment Bank to fund infrastructure projects and redirecting EU development funds to create jobs.
"Given the likely slow growth of private demand during the prolonged period of adjustment … actions at the European level could help to speed up the process and generate a more propitious environment in which to undertake structural reforms," the report said.
"EU-wide measures would strengthen activity … by boosting confidence and making it easier to achieve the intra-euro rebalancing effort," the OECD said.