Weak global economic growth needs to be countered by decisive policy action, according to the Organization for Economic Co-operation and Development.

In its latest economic outlook, the OECD says that euro area sovereign debt crisis remains the biggest downside risk, and that decisive action is needed to keep it from spreading and weakening global economic activity even further. If concerns about sovereign debt sustainability are not addressed, it warns that contagion to countries thought to have relatively solid public finances could massively escalate economic disruption. Pressures on bank funding and balance sheets increase the risk of a credit crunch, it adds.

Another serious downside risk is that no action would be agreed to offset the large degree of fiscal tightening implied by current law in the United States, which could tip the economy back into a recession that monetary policy could do little to counter, the OECD says.

It currently predicts that U.S. GDP will rise by 2.0% in 2012 and by 2.5% in 2013, after an expected expansion of 1.7% this year. Euro area growth is forecast to slow down from 1.6% this year to 0.2% next year, before picking up to 1.4% in 2013. In Japan, GDP is expected to expand by 2% in 2012 and 1.6% in 2013, following a contraction of 0.3% in 2011, which reflects the impact of the earthquake and tsunami and subsequent reconstruction activity.

“Prospects only improve if decisive action is taken quickly,” said OECD chief economist, Pier Carlo Padoan. “In the euro area, the risk of contagion needs to be stemmed through a substantial increase in the capacity of the European Financial Stability Fund, together with a greater ability to call on the European Central Bank’s balance sheet. Much greater firepower must be accompanied by governance reforms to offset the risk of moral hazard.”

Improved prospects would also depend on the enactment of a credible medium-term fiscal programme in the U.S., he adds.

The OECD outlook’s baseline scenario assumes that policy-makers take sufficient action to avoid disorderly sovereign defaults, a sharp credit contraction, systemic bank failures and excessive fiscal tightening. It sees GDP across the OECD countries slowing from 1.9% this year to 1.6% in 2012, before recovering to 2.3% in 2013. Unemployment in the OECD area is also projected to remain high for an extended period, with the jobless rate staying at around 8% through the next two years.

“We are concerned that policymakers fail to see the urgency of taking decisive action to tackle the real and growing risks to the global economy,” Padoan said during the launch of the report in Paris. “We see the U.S. growth recovering only slowly, the euro area entering into mild recession and Japan growing faster because of reconstruction, but this boost is temporary and will fade away.”

Additionally, the OECD projects Chinese economic growth easing to 8.5% in 2012, from 9.3% this year, before climbing back to 9.5% in 2013. Weaker activity in China and other emerging-market economies together with modest falls in commodity prices should put inflation in these countries on a downward trend, allowing some easing of monetary policy, it says.

Under the OECD’s baseline scenario, weak activity, low inflation and predominantly downside risks should trigger strongly accommodative monetary policy in OECD countries. “Central banks should provide ample liquidity to calm tensions in financial markets and prepare contingency plans that could be implemented swiftly if needed,” it says.

It warns that a continued lack of effective action could trigger an alternative, downside scenario where the outlook becomes much bleaker. ” This scenario could be prompted by a worsening of existing concerns about the banking system, contagion in euro-area sovereign debt markets or an excessively tight fiscal policy in the United States linked to the current political gridlock,” it says.

Also, it says that, where it’s feasible, governments should provide fiscal support while strengthening fiscal frameworks to reassure markets that public finances can be brought under control. “Under this scenario, a wide range of structural measures to boost jobs and economic activity, all desirable in their own right, will become urgent. Effective labour market policies are needed to tackle unemployment which risks turning from cyclical to structural, thereby sapping potential growth, hitting confidence and weakening public finances,” it says.