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IMF Report on U.S. Fiscal Policy, July 2011

Published July 25, 2011

International Monetary Fund (IMF) executive directors released their yearly report on the U.S. economic situation on July 25, 2011. The summary states,

"Executive Directors observed that the economic recovery continues at a modest pace, though slowing down recently due partly to some transient factors. Directors noted that depressed real estate markets, persistent high unemployment, and weak consumer confidence have held back growth prospects. While macroeconomic policies have remained supportive thus far, fiscal policy faces tighter constraints going forward, given unsustainable public debt dynamics. With a still-wide output gap and downside risks to the outlook, especially potential spillovers from European financial markets, Directors called for a cautious approach to unwinding macroeconomic support.

Directors agreed that placing public debt on a sustainable path is critical to the stability of the U.S. economy, with positive spillovers to other countries. They welcomed the administration’s objective to stabilize the debt ratio by mid-decade and gradually reduce it afterward. Directors highlighted the urgency of raising the federal debt ceiling and agreeing on the specifics of a comprehensive medium-term consolidation plan. With a well-defined, credible multi-year framework in place, the pace of deficit reduction in the short run could be more attuned to cyclical conditions.

Directors generally concurred that fiscal adjustment should start in FY2012 to guard against the risk of a disruptive loss in fiscal credibility. The strategy should include entitlement reforms, including additional savings in health care, as well as revenue increases, including by reducing tax expenditures. Directors welcomed the administration’s proposals for multi-year expenditure caps on non-security discretionary spending and a “failsafe” mechanism that would trigger automatic actions against deficit overruns.

Directors broadly agreed that, given prospects for subdued inflation and significant resource underutilization, an accommodative monetary policy will likely remain appropriate for quite some time. They called for continued vigilance to inflation developments and a decisive policy response as appropriate. When conditions warrant a monetary exit, a gradual reduction of asset holdings, accompanied by clear communication, was viewed as an essential first step.

Directors noted that further efforts are needed to address problems in the housing and labor markets. Measures to mitigate distressed sales and facilitate loan modifications would help stabilize house prices, while the reform of the government-sponsored enterprises should be accelerated. Directors encouraged a re-examination of existing active labor market programs, including job training and education programs.

Directors commended the authorities for the significant progress in repairing and reforming the financial sector, notably the implementation of the FSAP recommendations and the establishment of the Financial Stability Oversight Council. They encouraged the authorities to promptly allocate appropriate resources to fund the improvements in regulation and supervision, and to resist pressures to water down the legislation. Strengthening the crisis prevention framework for financial institutions is a priority, particularly in light of the global role played by the U.S. financial system. Directors emphasized in particular the importance of subjecting systemically important financial institutions to heightened scrutiny and prudential standards, and looked forward to further progress in this area. They commended the United States for its active engagement in fostering international coordination on financial regulatory reforms.

Directors welcomed a multilateral approach to economic policy management in the context of the spillover exercise. They noted that U.S. performance and policies have uniquely large spillovers to the rest of the world mainly through financial linkages, although some Directors noted that spillovers through the trade channel should not be underestimated. Important contributions that the United States can make to global growth and stability include (i) raising domestic savings, particularly through fiscal consolidation, and (ii) strengthening financial sector regulation and supervision. A number of Directors cautioned that the extraordinarily low level of interest rates in the United States may have encouraged excessive risk-taking, affected cross-border capital flows, and added to global inflationary pressures. Some also saw the potential risk of capital flow reversals that could arise from the eventual monetary exit by the United States, underlining the importance of policy communication, although some others were of the view that capital flows are driven increasingly by structural factors. Directors welcomed the authorities’ continued commitment to secure the success of multilateral trade negotiations."

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