BRUSSELS--Deflation risks in the euro area have risen and the European Central Bank should keep its interest rates at near zero over the medium term to tackle them, the Organization for Economic Cooperation and Development said in a report Thursday.
The report by the Paris-based rich-country think tank came as the ECB announced it would keep its basic refinancing rate unchanged at 0.25%, despite a flash estimate Monday that annual inflation in the euro area will drop to 0.5% this month.
"Risks of deflation or a protracted period of very low inflation remain as the large degree of economic slack has put persistent downward pressure on inflation, which is well below the ECB's quantitative definition of price stability," which is 2%, the report said.
It called on the ECB to consider "additional nonconventional measures" should deflation risks intensify. Greece, Cyprus and Spain are already experiencing deflation.
The chance of the euro area slipping into deflation would grow if economic activity in the bloc continues to be weak. A slowdown in emerging markets, and monetary-policy tapering in the U.S., would also increase the chances of deflation in the euro area, the OECD report said.
The report cited bad loans festering on euro-area bank balance sheets as a key risk to the bloc's fragile economic recovery. It called on the ECB to honor its pledge to be strict when reviewing the balance sheets of systemic banks as planned later this year.
Euro-area sovereign bonds, currently seen as bearing no risk for banks, should eventually be assigned varied risk weights in a way that doesn't destabilize financial markets, the report recommended. It said banks should be asked to hold capital against various euro-zone government bonds on their balance sheets, depending on how risky they are.
Currently all euro-zone government bonds, German or Greek, are formally seen as risk-free. Policy makers have said this should change, but there are no formal plans to reform the system to better reflect that some countries in the bloc are weaker than others.
The report's recommendations included: "Diversify, in the long run, the banks' exposure to the debt of a single sovereign. Assess the merits of leverage ratios, as a supplementary measure to risk-weighted ratios, for gauging the strength of bank balance sheets."
The OECD, often critical of euro-area decisions during the crisis, urged euro-zone governments to stay the course of prudent finances and debt-load cuts. It also said an overhaul of euro-area banking supervision, coming under direct ECB control this autumn, was the right call.
The OECD is a think tank whose members include wealthy nations from Europe and elsewhere, aimed at providing a forum for governments to jointly seek solutions to economic problems.
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The report by the Paris-based rich-country think tank came as the ECB announced it would keep its basic refinancing rate unchanged at 0.25%, despite a flash estimate Monday that annual inflation in the euro area will drop to 0.5% this month.
"Risks of deflation or a protracted period of very low inflation remain as the large degree of economic slack has put persistent downward pressure on inflation, which is well below the ECB's quantitative definition of price stability," which is 2%, the report said.
It called on the ECB to consider "additional nonconventional measures" should deflation risks intensify. Greece, Cyprus and Spain are already experiencing deflation.
The chance of the euro area slipping into deflation would grow if economic activity in the bloc continues to be weak. A slowdown in emerging markets, and monetary-policy tapering in the U.S., would also increase the chances of deflation in the euro area, the OECD report said.
The report cited bad loans festering on euro-area bank balance sheets as a key risk to the bloc's fragile economic recovery. It called on the ECB to honor its pledge to be strict when reviewing the balance sheets of systemic banks as planned later this year.
Euro-area sovereign bonds, currently seen as bearing no risk for banks, should eventually be assigned varied risk weights in a way that doesn't destabilize financial markets, the report recommended. It said banks should be asked to hold capital against various euro-zone government bonds on their balance sheets, depending on how risky they are.
Currently all euro-zone government bonds, German or Greek, are formally seen as risk-free. Policy makers have said this should change, but there are no formal plans to reform the system to better reflect that some countries in the bloc are weaker than others.
The report's recommendations included: "Diversify, in the long run, the banks' exposure to the debt of a single sovereign. Assess the merits of leverage ratios, as a supplementary measure to risk-weighted ratios, for gauging the strength of bank balance sheets."
The OECD, often critical of euro-area decisions during the crisis, urged euro-zone governments to stay the course of prudent finances and debt-load cuts. It also said an overhaul of euro-area banking supervision, coming under direct ECB control this autumn, was the right call.
The OECD is a think tank whose members include wealthy nations from Europe and elsewhere, aimed at providing a forum for governments to jointly seek solutions to economic problems.
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