Counter action required on US cuts

Risks to global markets will increase if governments do not act to counter a programme of strong fiscal tightening in America, the Organisation for Economic Co-operation and Development has warned.

The OECD has run simulations suggesting that, although the course of fiscal policy in America is uncertain, if the full range of proposed spending cuts are imposed in the subdued environment, America would move close to recession in 2012.

The OECD assu­mes a norm of fiscal consolidation in Ame­­rica at 0.75 percentage points of GDP in 2012 and one percentage point in 2013. (article continues below)

But under current legislation, including the Budget Control Act passed in August, these figures climb to 2% and 3% of GDP respectively if no offsetting action is taken.

In these worst-case circumstances, the consequences could be as much as 0.25 percentage point lost in output growth for other economies in 2012 and a reduction in the level of world trade by 1%.

The OECD’s latest General Assessment of the Macroeconomic Situation report warns that if America carries through the full extent of its proposed tightening, it could find it much harder to generate a recovery.

“Much tighter fiscal policy than in the projection could tip the US economy into a recession that monetary policy can do little to prevent,” says the report.

Just as American banks are at threat from a eurozone recession, the same is true of the reverse, the OECD says. “Fiscal policy in the US [is] likely to dominate economic developments [in the OECD] in the coming two years.”

The OECD calculates American banks’ exposure to vulnerable euro countries at about 21.9% of core capital (in total foreign claims). Other exposure (including gross credit default swaps) increases this exposure to 58.5%.

The situation worsens when further deterioration in the eurozone is factored in. If America introduces additional fiscal consolidation while the eurozone is still in crisis, the OECD forecasts a “prolonged and severe recession in the OECD economies and a large downturn in world trade”.