Key Points:

The OECD forecasts the New Zealand economy to continue to shrink next year as the world confronts the deepest recession since the early 1980s.

In its six-monthly economic outlook it estimates New Zealand's gross domestic product will have shrunk 0.5 per cent in 2008 and forecasts another 0.4 per cent decline next year.

"New Zealand has entered recession ahead of other OECD countries, a victim of simultaneous domestic and foreign shocks," it said.

"The outlook remains subdued because the large macro-economic imbalances which have built up over the past decade - inflation, housing overvaluation, high household debt and a huge current account deficit - will take some time to unwind."

But policymakers were well placed to cushion the downturn, it said.

"Tight monetary policy, in place for some time, is now being eased at a rapid pace and a fiscal expansion is starting from a position of significant surplus and low debt."

By 2010 it expects the unemployment rate to have climbed to 6 per cent (from 4.2 per cent now) as private consumption, which is around 60 per cent of economy activity, falls 0.7 per cent next year and does no more than claw that back in 2010.

The OECD forecasts - which it warns are subject to more than usual uncertainty - have the United States economy contracting 0.9 per cent next year, the euro area shrinking by 0.6 per cent and Japan by 0.1 per cent.

With the effectiveness of central banks' monetary policy weakened by the conditions of extreme financial stress, stimulus from governments' fiscal policy was especially important, it said.

"Infrastructure investment typically takes a long time to be brought on stream and, once begun, is difficult to wind down in line with a recovery in activity," OECD chief economist Klaus Schmidt-Hebbel said.

"Alternatives such as tax cuts or transfer payments aimed at credit-constrained, poorer households might prove more effective in boosting demand."

The incoming Government has pledged another round of tax cuts in April next year. Finance Minister Bill English said yesterday that while the stimulus packages announced in Britain and foreshadowed in the United States looked huge, proportionately they were comparable to New Zealand's.

"The package we are working on is a similar kind of stimulus package. Over two years there will be a fiscal impulse of 4 per cent of GDP, which is comparable to other countries."