US economy in stall through 2008: OECD


Posted at Jun 04 2008 07:14 PM | Updated as of Jun 05 2008 03:14 AM

Agence France-Presse

PARIS - The US economy is likely to contract in the second quarter and remain sluggish all year before a gradual recovery in 2009, the Organization for Economic Cooperation and Development predicted Wednesday.

The OECD lowered its forecast for US gross domestic product (GDP) growth in 2008 to 1.2 percent. In March, the interim OECD chief economist, Jurgen Elmeskov, had projected a 1.4 percent expansion.

"GDP is projected to nearly stall over the remainder of 2008, despite a continued positive contribution from net exports," the Paris-based organization said in a report.

The world's largest economy is forecast to contract 0.5 percent in the second quarter, pick up to 0.7 percent growth in the third and weaken to 0.2 percent in the final quarter.

"After stalling this year, real GDP growth should gradually return to potential next year," it said, forecasting a 1.1 percent expansion in 2009.

The US economy "is facing strong headwinds, which are exerting a sizeable drag on activity."

Private sector employment has declined for five consecutive months, "a trend that in the past has coincided with the onset of recessions." The OECD predicted the unemployment rate would rise to 5.4 percent in 2008, after 4.6 percent in 2007, and hit 6.1 percent in 2009.

The organization offered a dismal outlook on the battered housing market, where the sub-prime or high-risk mortgage crisis erupted in August 2007 and triggered a credit squeeze that is exacerbating the sector slump.

The OECD predicted housing prices would fall 10 percent through the end of 2009, reducing household wealth which in turn would weigh on private consumption, already under pressure from sky-high oil and other commodity prices.

"Tighter credit conditions, together with stagnating real disposable incomes and reduced confidence, will likely weigh considerably on household spending," the OECD said.

The federal government's tax-rebate checks will probably spur consumer spending in the second and third quarter.

The government would find it difficult to offer a second fiscal stimulus package "given the already high level of the general government budget deficit and looming long-term budget challenges of funding the entitlement programs," it said.

"The first-quarter figures indicate that the crisis has spread from residential investment, which contracted at a record rate, to non-residential investment, which contracted after posting solid gains over the previous few quarters."

As the economy stutters, "foreign trade has thus become the main engine of growth, with exports continuing to benefit from the weakening of the dollar and solid growth abroad."

On inflation, the organization forecast a rise of 3.2 percent this year and 2.0 percent in 2009. The growth of a "substantial" gap in the economy's output and higher unemployment -- "together with stabilization of commodity prices" -- should ease inflationary pressures, it said.

However, while core inflation has remained relatively well contained, "some indicators point to rising inflation expectations."

In this context, the Federal Reserve should not raise its key federal funds rate, currently pegged at 2.0 percent, "until such time as the economy is projected to be firmly recovering."

At that point, "the policy rate should be swiftly brought back towards neutral to keep inflation expectations under control."

The OECD said that "financial market regulation will need to be revised," notably to improve the oversight of use by banks of off-balance sheet activities, which has led to the current financial crisis.