March 31 (Bloomberg) -- The Organization for Economic Cooperation and Development forecast the steepest contraction in more than 50 years across its member nations and said central banks should use additional monetary tools to spur a recovery.

The combined economy of the world’s most-industrialized countries, will shrink 4.3 percent this year and 0.1 percent next, the Paris-based group said today in its latest projections. That compares with the 0.3 percent contraction forecast in November. All 30 OECD economies will be in a recession by the end of this year, something the group said was “unprecedented.”

“We are in the midst of the steepest, most synchronized recession in our life time, certainly since the 1930s,” OECD Chief Economist Klaus Schmidt-Hebbel said at a press conference in Paris to present the report.

Separately, World Bank President Robert Zoellick today said the global economy will likely shrink 1.7 percent, reversing growth of 1.9 percent in 2008. The OECD is also more negative than the International Monetary Fund, which forecasts advanced economies will contract between 3 percent and 3.5 percent this year. A recovery may take hold next year, the OECD said.

“We think there is a strong basis for forecasting a recovery, which will be hesitant at the beginning and then strong towards the end of 2010,” Schmidt-Hebbel said. The global economy is not headed for another “great depression,” he said.

Joblessness Rising

The worldwide financial crisis is forcing companies from Volkswagen AG to Agilent Technologies Inc. to reduce output and fire workers, threatening to push unemployment above 10 percent in the U.S. and the 16-country euro region, the OECD said. The number of unemployed in the Group of Seven nations will almost double from its level in mid-2007 to reach some 36 million people late next year.

Leaders from the Group of 20 emerging and developed nations will meet in London on April 2 to try to forge a common response to the crisis. U.S. calls for European nations to spend more on fiscal stimulus have met with some resistance by government’s trying to keep their budget deficits under control.

It was unlikely that world leaders would be able to agree to coordinate global stimulus measures, and the possibility that existing national stimulus plans may prove inefficient remains one of the biggest risks to a recovery next year, Schmidt-Hebbel said. Germany and Canada were among the countries that still had room to spend more to try to stem the contraction, he said.

U.S. Stagnation

Japan will contract the most among OECD members, shrinking 6.6 percent this year and 0.5 percent in 2010. The Paris-based institution sees the euro region contracting 4.1 percent in 2009 and 0.3 percent next year. The U.S. will contract 4 percent and then stagnate in 2010.

The World Bank singled out central and eastern European economies as the most vulnerable to the worst global recession since World War II.

“Developing countries are being battered by successive waves” as the advanced industrial economies contract and banks ration credit, Zoellick said in London today. “Countries in central and eastern Europe may be the most at risk.”

The OECD called on governments to remove toxic assets from banks and recapitalize them through nationalization if necessary. Countries should “avoid disguised trade protection” and those nations “that still have room to maneuver” should continue monetary and fiscal easing.

Interest Rates

The OECD urged central banks to keep lending costs close to zero to help get credit flowing again. The Federal Reserve’s key rate will remain at 0.25 percent until the end of 2010, and the European Central Bank will bring its benchmark rate, currently 1.5 percent, to close to zero by the end of June, the group said. The OECD based its projection for Japan on short-term rates there holding at 10 basis points.

Still low rates won’t be enough to get credit markets working again and the OECD urged central banks to follow the Federal Reserve’s lead in adopting measures other than adjusting monetary policy to spur lending.

“The monetary authorities should also be ready to implement or expand their use of direct measures to support credit creation, enhance liquidity in markets and to limit deflationary pressure,” Schmidt-Hebbel also wrote.

In the euro area, the ECB has so far resisted using additional policy tools such as buying corporate bonds. “With the bleak economic outlook, quantitative easing should be used to support demand,” the report said.

Inflation Risk

In the U.S., where the central bank has started to purchase Treasury bonds and taken a raft of other measures to sustain markets, the Federal Reserve will have to be ready to tighten policy once demand recovers.

“Once recovery is well underway and financial conditions are normalized, the Fed will need to start raising interest policy rates in order to keep inflation expectations well anchored, something expected to happen beyond 2010,” the OECD said.

Deflation “appears to be a significant risk for many OECD countries in 2010,” according to the report, which suggests raising inflation targets in some countries “once the situation has normalized.”

For Related News and Information: OECD stories: NI OECD <GO> Central bank coverage: NI CEN <GO>

Last Updated: March 31, 2009 07:33 EDT