US, China must lead global rebalancing

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EXIT STRATEGIES
The document said G7 countries should coordinate and clearly communicate in advance their plans to withdraw fiscal stimulus to help control inflation, among other things.

"Increasing budget deficits and public debt could weigh on the economies going forward. Clearly communicated medium- to longer-term policy frameworks are an essential component for stabilising expectations," it said.

It said inflation in the euro zone, which the European Central Bank wants to keep below, but close to, 2 percent over the medium term, was likely to rise moderately near term.

"The outlook further out is for relatively subdued inflation rates, as the sizeable slack in the product and labour markets can be expected to restrain inflation."

The world economy was improving but that was partly due to government support. "Looking forward, moderate optimism is warranted on the back of recent macro-economic indicators and normalising financial markets," it said.

"Overall, available leading indicators suggest a modest resumption of growth in the coming months, while Asian continues to show dynamism," it said.

But it cautioned the recovery could run out of steam if private demand did not kick in once fiscal stimulus is gone.

"This is particularly worrying given that unemployment is expected to stay high in the short term, precautionary saving has increased, private sector deleveraging continues and also given the negative wealth effects as a result of the crisis," it said.

"The pace of recovery is expected to be gradual and growth subdued, while risks remain given the high unemployment rates and the recent increase in commodity prices," it said.

FX VOLATILITY A THREAT TO RECOVERY
Volatile markets were another threat to stable growth.

"Market volatility, in particular in the foreign exchange market, as well as the possible build up of new asset bubbles, could destabilise the nascent global recovery by placing growth on an unbalanced path and trigger unwelcome protectionist reactions," the document said.

In remarks to Japan, the euro zone document said medium-term fiscal consolidation was a key challenge.

"As the risk of a protracted recession dissipates, ambitious fiscal consolidation should be considered," it said.

It also said that over the medium term, higher Japanese interest rates would help correct current account imbalances and anchoring inflation expectations.