The European Central Bank should consider providing more liquidity and commit to keeping rates low for longer if the sovereign debt crisis threatens to choke off an already fragile economic recovery, the Organization for Economic Cooperation and Development said.
“If the crisis were to re-intensify,” non-standard measures “may need to be widened to support the monetary transmission mechanism and maintain price stability,” the Paris-based OECD said in a report published today. “Commitments to maintaining low interest rates for a long period could also be considered, although communication implications would need to be assessed.”
The ECB has loaned banks more than 1 trillion euros ($1.3 trillion) for three years at its benchmark rate, which is currently at a record low of 1 percent, to keep credit flowing. With the 17-nation euro economy showing signs of stabilizing, ECB policy makers have signaled they’re reluctant to add to stimulus measures and started to talk about their eventual withdrawal.
“While the effect of recent ECB measures is still unfolding, the outlook for growth is unusually uncertain and depends critically on the resolution of the sovereign debt crisis,” the OECD said. “While effective policy action to resolve the crisis could lead to a stronger than anticipated and earlier recovery in confidence and investment, there are large downside risks as the lack of effective policy action would open the way to a severe recession.”
The ECB this month predicted the euro-area economy will contract 0.1 percent this year and expand 1.1 percent in 2013. The OECD today reiterated its November projections for growth of 0.2 percent this year and 1.4 percent next year.
Economists predict the Frankfurt-based ECB will keep interest rates unchanged through mid-2013, a Bloomberg News survey shows.
The region’s debt crisis has eased after the ECB’s liquidity support reopened financial markets and European Union leaders sealed a second Greek bailout package. Finance ministers will this week discuss expanding the region’s financial backstop to improve confidence in the single currency.
“Immediate action is required to ensure sufficient and large-scale availability of a firewall to stop the dynamics of runs against solvent sovereigns,” the OECD said. “The funds should be available on a scale sufficient to withstand possible future requests for financial assistance.”
“These possible needs could include estimated refinancing needs of vulnerable euro-area countries of over 1 trillion euros over the coming two years and contributions to the recapitalization of euro-area banks,” the OECD said. “Although it is unclear that funds on this scale would ever need to be drawn down, the availability of credible firewalls may enhance confidence.”
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