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Activity has stagnated after contracting in end-2011 and unemployment is set to rise further, owing to weak confidence and difficult financial conditions related to the sovereign debt crisis. Provided that policy actions are sufficient to improve confidence, activity will begin gradually to recover in the second half of 2012, notwithstanding fiscal consolidation and private sector deleveraging. There will be a marked divergence between stronger growth in creditor countries and a weaker and delayed recovery in those with a large debt overhang. The large margin of spare capacity will moderate underlying inflationary pressures. The main risks centre on intensification of the debt crisis and the economic effects of high public and private indebtedness.
Recent decisions have significantly increased the capacity of the firewall to address government funding problems. However, issues remain, including: how to rapidly marshall funds from diverse sources; how to address more protracted and large funding gaps; how to simultaneously address needs of governments and banks; and how to deal with disturbances in secondary markets. To support growth, monetary conditions should be further eased and bank balance sheets should be strengthened while avoiding excessive deleveraging. Substantial fiscal consolidation is needed, but each country’s response to the downturn should depend on the strength of its fiscal position. Abrupt fiscal adjustments should be avoided where growth disappoints. With scope for monetary and fiscal stimulus limited, reforms to labour market institutions, product market regulations and the tax system are needed to sustain growth and boost jobs.
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