A U.S. debt default would create significant confusion and uncertainty in financial markets and could prove as catastrophic as the failure of Lehman Brothers in 2008, the Organization for Economic Cooperation and Development (OECD) said in a new report.
Lawmakers in the U.S. side-stepped a debt default at the 11th eleventh hour in October and brought an end to prolonged negotiations over raising the debt ceiling. But talks are set to resume in the new year with the debt ceiling extended until February 7 and funding approved until January 15.
"An outright default would have extremely severe effects" the OECD said in the report, released on Tuesday.
"It would be likely to create large confusion and uncertainty in financial markets given the importance of U.S. government bond rates in pricing financial instruments worldwide and the widespread use of U.S. government bonds as collateral in many financial operations, and trigger a systemic flight to liquidity that could prove as catastrophic and costly as that in the day following the Lehman failure in 2008."
Even the possibility of an outright default would unsettle financial markets worldwide, and damage confidence, the OECD said, calling for the scrapping of the nominal debt ceiling altogether, so that the borrowing implied by budgets and resolutions passed by Congress is authorized automatically.
(Read More: US fiscal 'fiasco' biggest threat for 2014: Nomura)
In another scenario, it predicted that if the lawmakers couldn't reach an agreement on the debt ceiling and an extension was not an option, it would have "large adverse effects on the stability and growth of the world economy."
"A failure to raise the debt ceiling would likely be accompanied by a severe deterioration in financial conditions, with significant declines in equity prices worldwide, a higher term premium on U.S. government debt and, possibly, a worldwide rise in risk aversion." it said.
It estimates that even in the absence of adverse financial effects, a contraction of at least 4 percent of GDP (gross domestic product) in federal spending would be required to achieve a balanced budget. The U.S. economy would be pushed into recession immediately, with large negative spillover effects on other economies and substantive disinflationary pressures, it added.
"If, as most likely, the expenditure reduction was accompanied by deteriorating financial conditions, the consequences for the global economy would be much more severe, with a contraction of at least 5 percent of GDP in federal spending required for a balanced budget. The OECD as a whole would be in recession, with more than an additional 5 million people becoming unemployed," it said.