UN Says ‘Deflationary Spiral’ Looms as Consequence of Austerity

Premature fiscal austerity in Europe and the U.S. is pushing the global economy closer to a “deflationary spiral” that will choke consumption and leave millions of people without work, the United Nations said.

China, Germany and Japan need to boost domestic consumption while U.S. citizens must start consuming less to start fixing world economic imbalances, the UN said today in its annual Trade and Development report.

“A continuation of the expansionary fiscal stance is necessary to prevent a deflationary spiral and a further worsening of the employment situation,” the Geneva-based UN Conference on Trade and Development said in the 204-page report. “Not all countries can rely on exports to boost growth and employment. More than ever they need to give greater attention to strengthening domestic demand.”

European nations including Greece, Ireland and Spain have announced austerity measures that reduce public-employee pensions and salaries. In the U.S., states and municipalities are cutting services, including the number of hours worked by emergency workers and teachers. Politicians intent on retrenching public finances may unintentionally cause greater harm, according to the report.

“The prospect of a premature exit from stimulus in Europe has heightened the risk of a double-dip recession in that region, or even worldwide,” the UN said. “It is often overlooked that a double-dip recession, through its negative impact on public revenue, could pose a greater threat to public finances than continued fiscal expansion.”

Growth Forecast

The European Commission yesterday said growth rates in the 16-nation euro area would slow to 0.5 percent in the current quarter and 0.3 percent in the fourth. The commission doubled the region’s annual growth forecast to 1.7 percent.

The U.S. faces “strong headwinds” and pre-crisis patterns as the federal government’s stimulus runs out, the housing market remains depressed and politicians seek to plug budget gaps, the UN said.

“In the United States, a downward adjustment of consumption will be unavoidable unless wages grow strongly, which seems unlikely,” Supachai Panitchpakdi, head of the UN Conference on Trade and Development, wrote in the report’s introduction.

The UN scolded Germany for pushing other countries to make budget cuts and pandering to market forces calling for austerity.

Spreading Austerity

“Following Germany’s lead in committing to unconditional fiscal consolidation to regain market confidence, fiscal austerity is set to spread across Europe in 2011,” the UN said. “The short-term effects of fiscal austerity, including job losses, are unlikely to be offset by sharply falling interest rates and greater confidence in long-term prospects.”

The euro’s depreciation in the first half of 2010 meant Europe was exporting unemployment to the rest of the world, according to the UN.

The UN was more upbeat about the prospects of economies in Brazil, China, India and Southeast Asia, which have led the global recovery. It cautioned developing economies to prepare currency controls to prevent excess speculation.

Higher growth rates “could well lead to an increase in net private capital flows to the emerging-market economies,” the UN said in the report. “This, in turn, could generate upward pressure on exchange rates and may require currency-market intervention with a view to preventing exchange-rate appreciation as well as to provide self-insurance against speculative carry-trade operations.”

Germany, Japan

The burden of trade and consumption adjustments rests with countries that have a budget surplus, according to the UN.

“The import potential of Brazil, India, Indonesia and South Africa combined is not even equivalent to that of Germany and, with the exception of Indonesia, these countries have not had current-account surpluses in recent years,” the UN said. “Thus the key element in demand-management worldwide would have to be expansionary adjustment in the industrialized economies that have the largest surpluses, namely Germany and Japan.”

The 46-year-old UN group began warning in 2006 about financial imbalances leading to a global recession.

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