Concluding Remarks of 1998 Article IV Consultation--United States

July 14, 1998

At the conclusion of annual Article IV bilateral discussions with the authorities, and prior to the preparation of the staff's report to the Executive Board, the IMF mission often provides the authorities with a statement of its preliminary findings.
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1998 Article IV Consultation with the United States of America
Statement of the Fund Mission
July 14, 1998

1.  The implementation of sound monetary and fiscal polices over the past five years has made a major contribution to the outstanding performance of the U.S. economy and has helped to establish a solid foundation for continued economic expansion. As a result of decisive actions and their firm implementation, the federal fiscal balance has shifted from a large deficit in FY 1992 to an expected surplus of 1/2 percent of GDP in FY 1998, the first U.S. budget surplus in almost 30 years. At the same time, monetary policy has supported the economic expansion, while maintaining inflation at a low rate. Flexibility in labor and product markets has restrained inflationary pressures and bolstered employment growth, reducing the unemployment rate to its lowest level in decades. From an external perspective, the current strength of the U.S. economy will facilitate adjustment in countries affected by the financial crisis in Asia and will help to maintain growth in the world economy. The IMF staff highly commends the authorities for their sustained policy efforts and the successful performance of the economy.

2.  Assessing the underlying strength of economic activity in the United States, especially in view of the uncertainties associated with the effects of the Asian crisis on U.S. growth and economic prospects in these countries, represents a key challenge for the monetary authorities in the period immediately ahead. With the U.S. economy estimated to be operating at a very high level of resource utilization, preventing the emergence of inflationary pressures will depend critically on aggregate demand growing at a rate more in line with the economy's productive capacity. Whether inflationary pressures will remain quiescent in 1998 and into 1999 also depends on the extent to which the various forces that have restrained increases in prices (including the appreciation of the U.S. dollar and declines in energy and other commodity prices) can be expected to persist. Given recent inflation performance and the prospects for a moderation in aggregate demand growth during 1998, the current stance of monetary policy is appropriate for the time being.

3.  In the absence of further adverse economic shocks from Asia and the rest of the world, labor market conditions are expected to remain tight in the United States, and the influence of factors restraining inflation is likely to wane in the period ahead, especially as growth picks up abroad, contributing to reduced upward pressure on the value of the dollar and diminished competitive pressures and rising commodity prices. The authorities will also need to watch developments carefully in asset markets, especially the stock and real estate markets, and in the monetary and credit aggregates, all of which have posted strong gains recently. Absent deflationary shocks from abroad, and if the underlying strength of the U.S. economy reasserts itself, monetary policy is likely to need to be tightened at some point beyond the next three to six months. Under these circumstances, delaying a monetary policy response until there is clear evidence that inflation is on the rise would risk losing hard-won ground on inflation and inflation expectations. It cannot be ruled out, however, that monetary policy might instead need to be loosened if weaker economic conditions in Asia, together with instability in world financial and foreign exchange markets, slow the U.S. economy by significantly more than is currently anticipated.

4.  Beyond the immediate questions regarding monetary policy, the future course charted for fiscal and structural policies will be critical to ensuring a sustained favorable performance of the economy. In the area of fiscal policy, last year's agreement between the Administration and the Congress on measures to balance the federal budget by FY 2002 established a firm foundation for further improvements in the fiscal position over the medium term. However, the fiscal restraint exercised since 1993 is already giving way in some quarters to premature calls for net tax cuts and/or spending increases. Budget discipline is likely to come under additional pressure in the medium term, as existing spending caps increasingly restrict discretionary spending at a time when overall budget surpluses may be growing. The IMF staff strongly supports efforts to preserve the budget surpluses in prospect over the next few years. Achieving these surpluses would help contain the growth of aggregate demand in the near term, which is appropriate at this juncture, and, more importantly, these surpluses could serve as a down payment toward resolving the longer-term financial problems of the Social Security and Medicare programs.

5.  The IMF staff believes that an appropriate longer-term fiscal policy objective would be for the authorities to deal promptly with the looming financial problems of Social Security and Medicare, while keeping the rest of the budget in balance. In this way, sufficient resources could be set aside to meet Social Security's and Medicare's future spending requirements. At the same time, a sound fiscal position would be maintained, giving a needed boost to national savings.

6.  Efforts to address Medicare's longer-term financing needs should not rely solely on increases in payroll taxes and should distribute the cost of improving Medicare's finances across generations. Reform options to be considered include combinations of increases in the Medicare payroll tax, further constraints on payments to health-care providers, increases in the costs paid by Medicare beneficiaries, and some increase in the age of eligibility. It has also to be recognized that a once-and-for-all fix to Medicare's long-term finances may not be possible, owing to the difficulties in projecting the demand for health care and the costs of medical services, and periodic adjustments in the program might be required.

7.  It is also important to put in place a plan to shore up Social Security's longer-term financial position as soon as possible. A combination of relatively small increases in contribution rates and reductions in benefits (together equivalent to roughly an increase of 2 1/4 percentage points in contribution rates) would be sufficient to restore the system's long-term financial viability, if these changes were enacted soon. The IMF staff believes that prompt action to shore up the longer-term finances of the system by small adjustments in its parameters would be preferable to a more radical reform. More radical approaches to reform, such as a full privatization of the system, on their own are not likely to provide the increase in national savings needed to address the long-term financial problems associated with the aging of the population. They could also entail considerable risks associated with uncertainties regarding their implementation and performance. Moreover, a more radical reform could face significant political hurdles that could unduly delay its implementation.

8.  Tax measures proposed by the Administration in its FY 1999 Budget continue a tendency to use tax incentives to promote specific economic or social objectives. Such incentives increasingly complicate the income tax system and undermine the simplification of the tax code achieved by the Tax Reform Act of 1986. The IMF staff urges the authorities to consider measures to simplify the income tax system (including reductions in tax expenditures and possible modifications in the tax rate structure to limit the number, and lower the level, of marginal tax rates).

9.  The appreciation of the U.S. dollar in late 1997 and early 1998 and the accompanying rise in the U.S. external current account deficit will have the short-term salutary effect of supporting external adjustment in the hard-hit Asian economies, while helping to ease demand pressures in the United States. As the economic situation in Asia stabilizes, the IMF staff believes that some reversal of safe-haven capital flows and some depreciation of the dollar can be expected, contributing to a narrowing in the U.S. external current account deficit. Over the medium term, an additional real depreciation of the dollar may be needed if large current account deficits persist. Given the continued implementation of fundamentally sound macroeconomic policies in the United States, it is expected that this correction in the dollar's value will be an orderly process. Moreover, a crowding out of U.S. investment (potentially stemming from a correction in the external deficit) could be avoided by pursuing the longer-term fiscal policy objective of setting aside the necessary resources to meet the future spending requirements of Social Security and Medicare and keeping the rest of the budget in balance, which would significantly raise national saving.

10.  The IMF staff commends the authorities for their continued efforts to promote trade liberalization on terms supportive of the multilateral trading system, and emphasizes that it is important that the United States continues to play a leadership role in this area. It is also important in the period immediately ahead that protectionist pressures, which may arise as a result of the effects on trade flows of the crisis in Asia, are strongly resisted. The United States remains a major force behind the advancement of trade liberalization in new sectors (for example, information technology and telecommunications) and through regional (including the North American Free Trade Agreement, and the initiative for a Free Trade Area of the Americas) and multilateral fora. The IMF staff also commends the authorities for their use of the WTO's dispute-settlement mechanism to resolve trade disputes, rather than resorting to unilateral actions as was done at times in the past. Notwithstanding strong U.S. support for open trade, sectors such as agriculture and textiles and apparel have retained relatively high trade barriers. The IMF staff urges the United States to lead by example in accelerating trade liberalization of these sectors.

11.  The Administration's FY 1999 Budget would hold official development assistance at historically low levels as a percentage of GDP over the five-year budget horizon. The IMF staff urges the authorities to restore the leadership role of the United States in this area by making every effort to raise ODA expenditures, helping to reverse a downward spiral in such assistance that appears to have developed on a world-wide basis.