The Organization for Economic Cooperation and Development said Monday policy makers around the world must "be prepared to face the worst," as the economic impact of Europe's debt crisis threatens to spread around the developed world.
The Paris-based OECD said in its latest Economic Outlook that continued failure by EU leaders to stem the debt crisis that has spread from Greece to much-bigger Italy "could massively escalate economic disruption" and end in "highly devastating outcomes."
The half-yearly update also recommended urgently boosting the EU bailout fund and called on Europe's central bank to do more to stem the crisis.
"The ECB has the means to provide a credible measure to avoid further contagion in the sovereign bond markets," the OECD's chief economist Carlo Padoan said. "And if you ask me if that is the lender of last resort function, I would say yes."
Many think the ECB is the only institution capable of calming frayed market nerves and Merkel's continued dismissal of a greater ECB role knocked market sentiment and stocks all round Europe fell again after a morning rebound.
Potentially, the ECB has unlimited financial firepower through its ability to print money. However, Germany finds the idea of monetizing debts unappealing, warning that it lets the more profligate countries off the hook for their bad practices. In addition, it conjures up bad memories of hyperinflation in Germany in the 1920s.
Padoan also upped the pressure on Europe to implement the Greek debt restructuring agreed to by EU leaders in October, saying that further delay could render the plan "insufficient," just as an earlier plan unveiled in July turned out to be.
The OECD now forecasts the eurozone economy to be in a six-month recession lasting through the first quarter of 2012, followed by a slow recovery that will leave the 17-nation bloc with only 0.2 percent growth next year.
Despite the OECD's warning, European markets enjoyed one of their best sessions in weeks amid hopes that radical plans were being readied for the Dec. 9 meeting of EU leaders in Brussels. The Stoxx 50 of leading European shares ended 3.6 percent higher at 2,208.89.
Padoan warned however that a combination of factors including continued fiscal gridlock in the U.S. and a sovereign debt default or bank failure in Europe could result in a "downside scenario" that sees the eurozone shrink by 2 percent next year and even more in 2013.
The OECD expects the U.S. to grow by 2 percent next year and 2.5 percent in 2013, while the Japanese economy is forecast to grow 2 percent next year and 1.6 percent in 2013.