7:43 PM Jun 20, 1996

OECD NUDGING MONETARY AUTHORITIES TO EASE

Geneva 20 (Chakravarthi Raghavan) -- The Paris-based Organization for Economic Cooperation and Development, the club of the rich nations, has cautiously advocated "judicious use of monetary easing" in key countries of Europe with a view to help raising output and employment.

In its semi-annual "Economic Outlook No 59", the OECD has suggested that conditions for such easing without generating inflationary pressures appears to exist in some key countries where there is significant slack in output and labour markets, little prospect of inflationary pressures and a pressing need for fiscal consolidation.

The publication projects for the OECD area a 2.1% GDP growth in GDP in 1996 and a 2.5% in 1997.

The short-term outlook, the OECD secretariat says, is for greater convergence across the main OECD regions, with continued sustained growth in the US (where it projects a 2.2% growth this year, slowing down to a 1.8% next year), a more sustained recovery in Japan and a pickup in Europe.

In the US the recent rise in long-term rates is seen as helping to hold growth at a sustainable pace, while in Japan with low short-term rates remaining low, the rise in value of yen more in line with its fundamentals has effectively eased monetary conditions. In Europe, while short-term rates have fallen significantly in many countries, the recent rise in long-term rates may damp activity.

Outside the OECD area, activity is expected to be buoyant, particularly in the dynamic Asian economies and China, and increasingly in other areas as well.

The report notes that most OECD countries have come close to achieving medium term goal of price stability, with inflation expected to be below three percent in 19 OECD countries. It is important, the OECD argues, for monetary policy to safeguard gains on this front, and the primary objective of monetary policy should be maintenance of price stability -- rather than fine-turning real economic activity and running the risk of compromising the goal of price stability.

But in a situation where there is significant slack in output and labour prospects, little prospect of inflationary pressures and a pressing need for fiscal consolidation -- a situation which appears to exist in some key countries in continental Europe -- judicious use of monetary easing could help raise output and employment without generating inflationary pressures, the OECD affirms.

But to avoid possible financial market turmoils, the easing could be justified i a way that places it in the medium-term context of price stability. Improved institutional frameworks in many countries, including greater central bank independence and accountability or a more explicit medium-term framework for monetary policy -- could help enhance and sustain credibility of monetary policy and reduce risk that policy-induced cut in short-term rates could adversely affect medium- and long-term interest rates or put unwanted downward pressure on exchange rates.

But in countries like the US where the economy is operating close to its potential, the central bank should err on the side of caution.

In Japan, the easy stance of monetary policy should be maintained.

In most OECD countries the most urgent requirement is restoring health of public sector finances -- reducing budget deficits and reversing the rise in debt-to-GDP ratios.

But the pace of deficit reduction in the short-term depends to some extent on current and prospective economic conditions:

* in the US, where plans have been formulated to balance the budget by early in the next decade, Congress and Administration must follow through by agreeing on specific measures and implementing them as quickly as possible;

* in Japan, where substantial discretionary fiscal expansion has helped sustain demand, but the deficit and public debts are unsustainably high, deficit reduction should begin soon and proceed as rapidly as the underlying strength of domestic demand allows;

* EU countries should remain firmly and jointly committed to reducing their structural budget deficits beyond 1997 to well below three percent. With such commitments ensuring credibility of fiscal policy, governments could use automatic stabilisers to deal with short-term economic weakness without undermining the process towards the European Monetary Union.

While underlining the need to address issues of heavy tax burdens and distortions and need for fiscal adjustment, the OECD cautious that such fiscal consolidation should be carried out in a manner that is both fair and efficient.

"Policies must ensure that benefits of economic growth are shared by all and, in particular, those most in need must continue to be protected to prevent emergence of exacerbation of poverty and social exclusion."

The quality of public outlays must be improved and reforms of structure of expenditures should be part of a wider effort to improve performance of the government sector. Reform of governance and management would help ensure that government programmes are responsive to social needs and that the public receives the best possible services at the least cost.

The secretariat also underlines the need for urgent measures to reduce unacceptably high unemployment through reforms including reducing barriers to employment, labour market flexibility, reducing employment costs and overall disincentives to work by reforming the tax and transfer systems, enhancing effectiveness of active labour market policies, and promoting dynamism in product markets through greater competition, entrepreneurship and effective innovation.

The report also stresses need for structural reforms across a broad front. While such reforms have progressed farthest in financial markets, further measures to promote efficient transactions, internationally and within countries, should be combined with measures to strengthen prudential oversight, competition and consumer protection.

But in provision of public services and in labour markets, reforms are less advanced and there are still many regulatory barriers to both domestic and international competition. Progress in these areas, along with measures to protect those that might be seriously and adversely affected, would improve flexibility and performance over the medium term.