Time to rethink euro zone cutbacks, OECD says

BRUSSELS Tue Nov 27, 2012 10:11am GMT

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BRUSSELS (Reuters) - The euro zone should ease up on deep government spending cuts but stick to the path of reform, the OECD said on Tuesday, adding its voice to those calling for a softening of cost-cutting they see as choking economies.

Budget cuts are at the centre of the euro zone's strategy to overcome a three-year public debt crisis, but since the bloc sank back into recession this year, policymakers are beginning to question the wisdom of such aggressive deficit reduction.

Against a backdrop of record unemployment and strikes across Europe this month, the Organisation for Economic Co-operation and Development said in a report that simultaneous spending cuts in almost all euro zone countries had worsened the crisis.

It now urged those countries that could afford to, such as Germany, to be prepared to increase spending to help growth.

"We recognise that one of the causes of the slowdown is fiscal tightening," OECD chief economist Pier Carlo Padoan told Reuters.

"If the situation deteriorates further, those countries with fiscal space should use it, by possibly adding some stimulus or further discretionary easing if need be," he said, singling out Germany in the euro zone and China further afield.

After years of overspending, southern Europe is cutting public sector wages and spending on hospitals and schools, while Belgium and France are also under pressure to control their deficits. That is also translating into less demand for German goods and eating away at business confidence across the bloc.

The OECD's call follows an admission by the International Monetary Fund last month that the damage from aggressive austerity may be up to three times more than previously thought.

The Fund has since shifted its earlier advice to the 17-nation euro zone, now arguing against forcing heavily indebted countries such as Greece to reduce their deficits too quickly.

The European Commission, which polices the euro zone's efforts to bring down budget deficits, has also softened its stance, granting Spain and Portugal more time to meet EU-mandated fiscal targets. Euro zone finance ministers this month gave Greece two more years, until 2016, to reach its goals.

"BUYING TIME"

Given the apparent shift in policy, the Paris-based OECD said the euro zone should be clearer about its strategy, or risk a perception among investors that any country easing off on cutbacks was going off track.

"If there is agreement that the pace of consolidation in the euro area needs to be slowed down a little bit, then we recommend that this is announced and decided as a collective decision," Padoan said.

The euro zone's 9.4 trillion euro ($12 trillion) economy, which generates a fifth of global output, slid into its second recession since 2009 in the third quarter and full-year 2012 is expected to show it contracted slightly.

The Commission sees just 0.1 percent growth in 2013, while the OECD forecasts another year of contraction and partly blames government spending cuts. "Ongoing fiscal consolidation will hold back activity," the organisation said in its report.

Still, the OECD said economic reforms such as modernising rigid labour laws, winning back lost export shares and making public pensions sustainable remained vital.

The European Central Bank's new bond-buying programme for indebted euro zone countries that has calmed financial markets was no excuse for relaxing, the OECD added.

"We have gained in Europe a window of opportunity," Padoan said on the ECB's plan to buy government bonds of countries who request help from the euro zone's permanent ESM bailout fund.

"But this is only buying time," he said, calling on euro zone leaders to concrete plans for a banking union, a system to strengthen the monitoring and support of the region's lenders.

(Additional reporting by Leigh Thomas in Paris. Editing by Jeremy Gaunt.)

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