Wednesday, July 27, 2011

The IMF on the U.S. Economy #1: What About the Budget Deficits?

The IMF has released its annual report on the U.S. economy, with a number of interesting figures, tables and insights. Here, I'll offer some IMF comments on the U.S. fiscal situation and  how the U.S. should address its federal deficit problems. In a follow-up post, I'll look at an intriguing comparison that the IMF offers between the aftermath of the Great Recession and the previous nine U.S. business cycles

"Fiscal policy. Consolidation needs to proceed as debt dynamics are unsustainable and losing fiscal credibility would be extremely damaging. However, the pace and composition of adjustment should be attuned to the cycle. A politically-backed medium-term framework that raises revenues and addresses long-term expenditure pressures should be the cornerstone of fiscal stabilization. The official deficit reduction proposals could be too front-loaded given the cyclical weakness and, at the same time, insufficient to stabilize the debt by mid-decade." (p. 1)

"Unfavorable fiscal outcomes. These could take the form of a sudden increase in interest rates and/or a sovereign downgrade if an agreement on medium term consolidation does not materialize or the debt ceiling is not raised soon enough. These risks would also have significant global repercussions, given the
central role of U.S. Treasury bonds in world financial markets. At the opposite extreme, an excessively large upfront fiscal adjustment could significantly weaken domestic demand ..." (p. 11)

 "Short-term U.S. spillovers on growth abroad are uniquely large, mainly reflecting the pivotal role of U.S. markets in global asset price discovery. While U.S. trade is important, outside of close neighbors it is the global bellwether nature of U.S. bond and equity markets that generates the majority of spillovers." (p. 13)

"The authorities have a number of options to achieve fiscal sustainability without large negative short term effects on activity. Social Security reform would help reduce long-term fiscal imbalances without undermining the ongoing recovery—measures such as increasing the retirement age while indexing it to longevity and trimming future benefits for upper-income retirees would have a minimal impact on current private spending. Identifying additional saving in health care and other mandatory spending categories would also be highly desirable, including through greater cost sharing with the beneficiaries, curbs to the tax exemption for employer-provided health care, and targeted savings identified by the President’s Fiscal Commission. Meanwhile, the tax system is riddled with loopholes and deductions worth over 7 percent of GDP. Gradually reducing these tax expenditures (including eventually the mortgage interest deduction which largely benefits upper-income taxpayers) would help raise needed revenue while enhancing efficiency. In the
longer term, consideration could also be given to introducing a national VAT or sales tax, as well as carbon