The U.S. economy may face a graver threat from Europe's debt crisis than is currently thought, the Organization for Economic Co-operation and Development said in a report warning the recovery could be derailed.
In its latest economic outlook released on Monday, the OECD said the level of uncertainty surrounding the U.S. economy was high and risks were heavily tilted to the downside.
"Negative spillovers from the turmoil in European markets could be greater than expected and have the potential to derail the recovery in activity and renew fears among financially fragile households and businesses," it said.
So far, analysts and some Federal Reserve officials have played down concerns that the euro zone debt crisis, which has roiled financial markets, will hit the broader economy hard.
One reason they cite is that U.S. exports to the euro zone account for only about 2 percent of gross domestic product so the pain from the region's fiscal crisis will be transmitted mostly through declining stock prices.
The OECD forecast U.S. growth averaging 1.7 percent this year, picking up to 2.0 percent in 2012.
In the event of a shock from the debt crisis, the OECD recommends easing fiscal tightening by prolonging extended unemployment benefits and increasing access to income tax credits and food stamps.
"Effective activation measures will be vital to minimize a heightened risk of rising structural unemployment," the OECD said.
It forecast average U.S. unemployment of 9.0 percent this year, edging down to 8.9 percent in 2012.
FISCAL SUSTAINABILITY
The OECD's recommendation for strengthening so-called automatic stabilizers could get a lukewarm reception from lawmakers when pressure is on to slash ballooning government debt and politicians cannot agree where to make the cuts.
There are concerns that a 2 percent payroll tax holiday and extended benefits for nearly two million Americans will not be renewed when they expire at the end of next month.
Economists warn that, if that happens, it would place a drag on recovery. Still, the OECD said the United States needed to work hard to secure longer-term fiscal sustainability.
"A credible commitment to fiscal sustainability would aid the recovery by increasing confidence, reducing uncertainty and lowering the risk of disruptive logjams over the federal debt ceiling and possible resulting government shutdowns," it said.
Even though the Fed had cut its overnight lending rate to near zero and pumped about $2.3 trillion into the economy through asset purchases, the U.S. central bank still has options to support the economy, the OECD said.
"The FOMC decision to keep short-term interest rates at an exceptionally low level through at least mid-2013 was a welcome signal," it said. "Further actions to adjust the Fed's portfolio toward holding longer-dated securities could help ensure that the yield curve does not steepen."
Fed Chairman Ben Bernanke has said buying more mortgage-backed securities was an option to aid the economy.
The OECD also urged more measures to allow creditworthy households, with home loans worth more than the value of their properties, to reduce their payment burdens by refinancing.
This would reinforce a critical channel for low interest rates to stimulate the economy, it said.
The OECD said financial sector reforms laid out in the Dodd-Frank legislation needed to be implemented without delay as financial institutions would come under even greater stress if downside risks materialized.
"Action to introduce a macroprudential framework would provide confidence that financial stability will be maintained," it said. (Reporting by Lucia Mutikani; Editing by Andrew Hay)
