Keep rates low, OECD urges Canada

Emma Vandore,  Globe and Mail Update and The Associated Press

Paris — Canada appears to have emerged from recession but unemployment will continue to rise to the end of the year, the Organization for Economic Co-operation and Development said Thursday.

The OECD also urged the Bank of Canada to held its benchmark lending rate at an historic low through to June of 2010, as it has pledged, and probably even longer, but added the central bank and government should stop there.

“Given the time required to roll out fiscal stimulus and the nascent recovery, additional expansionary measures, including extending the window of eligibility for extraordinary unemployment benefits, should be resisted,” the 30-nation group said in its latest forecast. “Instead, governments should be preparing detailed and credible medium-term fiscal consolidation plans to be announced soon and be implemented when the recovery is firmly under way.”

The OECD, which more than doubled its estimate for 2010 growth among all 30 countries, projected the economy would shrink 2.7 per cent this year, but then grow 2 per cent next year and 3 per cent in 2011.

Notable, too, is that the group projected the unemployment rate would rise to 8.8 per cent this year, above the latest reading of 8.6 per cent in October, and remain there for several months.

The forecast was not without its warnings, however.

“The contraction that began in the last quarter of 2008 seems to have ended in the second half of 2009,” it said. “External demand and domestic investment now appear to be rebounding, but they also pose the greatest risks to the recovery's sustainability. Unemployment is projected to keep rising until the end of 2009 and underlying disinflation to continue for several more quarters under the weight of persistent slack.”

In its overall forecast, the OECD said the world's rich and developed economies will grow faster next year, but recovery will remain modest, with the U.S. and Japan outpacing Europe.

It more than doubled its estimate for 2010 growth to 1.9 per cent.

Still, the recovery is expected to remain fragile.

“In most OECD economies, growth is likely to fluctuate around a modest underlying rate for some time to come,” said the organization's top economist, Jorgen Elmeskov, in an editorial.

“It is being held back by still substantial headwinds. It is only some time down the line that the recovery will become sufficiently strong to begin to reduce unemployment.”

The OECD also reduced the expected contraction this year to 3.5 per cent from an earlier forecast of 4.1 per cent. The organization publishes its economic outlook twice a year, although it updated some 2009 forecasts in an interim assessment published in September.

The U.S. economy has been boosted by stimulus measures, improving financial conditions, demand from the fast-growing non-OECD economies of Asia – especially China – and the stabilization of the housing market, the OECD said. It predicted unemployment will start to ease after peaking in the first half of 2010.

It predicts the U.S. economy will expand at a rate of 2.5 per cent in 2010, up from a June forecast of 0.9 per cent. It also expects a smaller contraction this year: a 2.5 per cent fall in output compared with an interim September forecast of a 2.8 per cent drop.

In Europe, the economies of the 16 countries sharing the euro are now expected to grow by 0.9 per cent next year compared to a June forecast of zero growth. However, the OECD predicts a greater contraction of 4 per cent this year, more than the 3.9 per cent it calculated in September.

Unemployment is not set to peak before the end of 2010 or the beginning of 2011, and is likely to sap the strength of recovery, the OECD said.

Japan's economy will grow by 1.8 per cent next year compared with the June forecast of 0.7 per cent. The OECD reduced prediction for a contraction this year to 5.3 per cent compared to a 5.6 per cent rate seen in September.

Mr. Elmeskov said central banks should keep interest rates low and should beware of the dangers of deflation, while governments should work on plans to reduce debt levels as the economy recovers.

As growth picks up, policy makers will need to mop up some of the excess liquidity caused by policies designed to keep credit markets open when they threatened to freeze during the peak of the crisis.

The OECD suggests phasing out banks' use of funding guarantee schemes by making them more expensive rather than ending them, to avoid having to reintroduce them in case of renewed instability, which could undermine confidence.

International co-ordination will be needed to roll back extended deposit insurance “as few countries may be willing to move ahead alone with a measure that could weaken the competitiveness of domestic banks,” it said.