Concluding Remarks of 1999 Article IV Consultation -- United States
June 17, 1999
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Statement of the Fund Mission
June 17, 1999
1. The U.S. authorities are to be highly commended for their sound fiscal and monetary policies, which have contributed significantly to what is now approaching the longest economic expansion in U.S. history. Steadfast efforts to improve the fiscal outlook have helped to turn the unified federal budget balance to a surplus in FY 1998 for the first time in 30 years, and structural budget surpluses are expected to be sustained under current policies over the longer term. Monetary policy has continued to support the expansion while containing inflation. At the same time, strong employment growth, partly attributable to the flexibility of U.S. labor markets, has contributed to a decline in the unemployment rate to its lowest level in decades. During the recent difficult period of turbulence in the world economy, the United States economy has been the principal engine of global growth, and U.S. monetary policy played a key role in stabilizing international financial markets. In the period ahead, however, U.S. growth will need to slow from its recent rapid pace to a rate more in line with the economy's long-run potential. The policy challenge for both the United States and its international partners will be to ensure that a restoration of a more evenly distributed pattern of demand growth is accomplished in a nondisruptive manner.
2. In recent years, the supply side of the U.S. economy has behaved differently than expected by most analysts, including the IMF staff, with growth exceeding projections and inflation continuing to decline well into the period of sustained growth. Despite tight labor markets, wage demands have remained moderate, in part reflecting the effects of favorable price shocks that have contributed to unanticipated increases in real wages. Efforts to control benefits costs have reined in the rate of growth in employee compensation. At the same time, the appreciation of the dollar and the fall in commodity prices, along with stiffer competition in U.S. markets, have served to contain inflation. At this stage, a good deal of uncertainty surrounds estimates of potential output and the natural rate of unemployment, making these indicators less useful as guides for macroeconomic policy. Strong investment and continued productivity gains have probably raised potential output more rapidly than in preceding periods, but it is difficult to gauge the extent to which recent developments reflect a sustainable change in structural economic conditions and how much is attributable to transitory factors. Regardless of the uncertainty about the new limits of productive capacity, the economy still faces resource constraints, and the recent very strong growth in aggregate demand cannot be sustained for long without having inflationary consequences.
3. Although the performance of the U.S. economy has been remarkable, some significant risks have emerged. In particular, while national savings has increased substantially since 1992, personal savings has fallen to an unprecedentedly low level, partly reflecting the effects of the large gains in wealth associated with what many indicators suggest is a significantly overvalued U.S. equity market. At the same time, the external current account deficit has widened sharply, owing to the appreciation of the dollar and the rapid pace of domestic demand growth in the United States. Moreover, the factors that have contributed to the favorable wage and inflation performance in recent years may have only transitory effects. A reversal of these conditions, if it were to unfold rapidly, could cause problems for macroeconomic management. While the decline in personal savings and the rise in the current account imbalance, which reflects the relative cyclical positions of the U.S. and other major economies, do not warrant any immediate policy responses, they do heighten the potential risks associated with any overheating.
4. Unless there is evidence soon that the strength of demand growth is abating, the authorities may need to move to tighten monetary policy to ensure that the expansion remains on a sustainable, noninflationary path. Since economic conditions in the rest of the world and in global financial markets have improved somewhat, a modest tightening would have a less damaging effect than it would have had earlier. While judgements on the timing of such action are especially difficult in the current circumstances, waiting too long to act would risk having to raise rates more sharply later to stem a pickup in inflation, which would increase the likelihood of a sharp stock market correction and a "hard landing". The recent shift to a bias toward firming the stance of monetary policy in the intra-meeting period recognizes these potential pressures, and it will be especially important for the Federal Reserve to continue to respond rapidly and to be forward looking in its conduct of policy.
5. The Administration's intention to preserve a substantial portion of the federal budget surpluses in prospect over the medium term and beyond is laudable. Maintenance of substantial budget surpluses is appropriate for both short-term stabilization and long-term structural reasons. In the near term, resisting new tax and spending initiatives in order to realize the projected budget surpluses is essential to avoid adding further fuel to already strong aggregate demand pressures. In the long term, allowing surpluses to materialize will help prepare the federal government for the rising tide of unfunded liabilities associated with the aging of the population. The IMF staff believes that an appropriate longer-term fiscal objective would be to put the Social Security and Medicare programs into actuarial balance, and then keep the remainder of the budget balanced on average, allowing for changes in cyclical conditions.
6. Although a consensus appears to have emerged in Congress to maintain substantial surpluses, it will be necessary to continue to resist pressures to cut taxes and increase spending as the budget deliberations proceed. In this regard, discretionary spending caps and the PAYGO financing requirement have fostered discipline in the budget process, contributing to the sustained fiscal consolidation since FY 1992. These budget enforcement measures are set to expire in 2002, and the IMF staff believes that long-term budget discipline would be well served by appropriate modest adjustments to the spending caps and by extending both measures beyond their expiration.
7. Tax cuts proposed by the Administration in its FY 2000 Budget continue a tendency to use tax incentives to promote specific economic or social goals. These incentives complicate the income tax system, thereby undermining transparency and increasing compliance costs. With the aim of simplifying the income tax system, the IMF staff continues to take the view that the authorities should limit recourse to the use of tax expenditures.
8. The Administration's proposal for Social Security is a useful first step toward shoring up the system's finances, but further efforts are needed to achieve long-term actuarial balance. The total size of the funding gap is relatively small by international standards, and in principle, could be corrected without radical changes to the system. The IMF staff endorses the Administration's intention to maintain the system's current structure, which has been highly successful in reducing poverty among the elderly. Nevertheless, the proposed use of general revenues and the plan to invest a small portion of Trust Fund assets in equities raises important concerns. Removing the link between outlays and Social Security payroll taxes could potentially erode an effective budget constraint; one that probably has provided a check on unwarranted growth in Social Security benefits over the years. The Administration's plan to invest some Trust Fund assets in equities would contribute to improving the finances of Social Security, but its overall macroeconomic impact would be to simply shift the composition of public and private asset portfolios without substantially contributing to a needed increase in national savings. There is also the potential risk that investment of these funds in private securities could ultimately be influenced by political consideration, creating distortions which could adversely affect private sector investment decisions. In the view of the IMF staff, a comprehensive solution to Social Security's long-term financial problem should involve small adjustments in the system's parameters (increases in contribution rates, an increase in the retirement age, and/or cuts in benefits), which need to be enacted soon.
9. Although the Administration's proposal to transfer general revenues to the HI Trust Fund would also lessen the actuarial imbalance facing Medicare, it falls well short of restoring the long-term financial viability of the system. The IMF staff urges the Administration to consider a more comprehensive solution to Medicare's financial problems that would involve a menu of options, including reducing benefits, raising co-payments and deductibles, and increasing contribution rates. It also has to be recognized that periodic adjustments to the program are likely to be required because of the difficulties in projecting Medicare outlays, and a mechanism for making adjustments in the program's parameters on a regular basis should be established. Timely adoption of a comprehensive plan to shore up the longer-term financial viability of Medicare would avoid the need for more draconian measures at a later stage.
10. Over the past year and a half, the appreciation of the U.S. dollar has shifted demand abroad, helping to avert overheating in the United States and mitigating the adverse effects of global economic turbulence. As growth outside the United States recovers, especially in the economies of key trading partners, some reversal of safe-haven capital flows, and some depreciation of the dollar can be expected, helping to narrow the U.S. external current account deficit. The U.S. authorities need to continue to implement sound macroeconomic and structural policies to increase the likelihood that any correction in the dollar's value will be an orderly process. In particular, the prospects for sustained fiscal surpluses in coming years should raise national saving and help gradually to ease pressures contributing to the relatively high external current account deficit. Furthermore, if the dollar were to depreciate suddenly and sharply, the Federal Reserve, although not targeting the exchange rate, would be well-positioned, if needed, to tighten monetary policy in order to limit the risk of a sustained effect on inflation.
11. In the last year, the appreciation of the U.S. dollar and the weakness in domestic demand abroad has heightened competition faced by U.S. import-competing producers and is stimulating protectionist sentiment. It is in the interest of both the United States and the international community that these protectionist pressures be strongly resisted. In particular, steps need to be taken to ensure that protection from "unfair trade" in the form of antidumping and countervailing duties—even if they conform with WTO obligations—is not simply used as a means of inhibiting competition from imports. Rather, there are sound economic reasons for administering these procedures with the objective of providing import protection only in those cases where foreign producers are engaged in anticompetitive behavior. At the same time, the United States should continue to be a major force for the advancement of multilateral trade liberalization in order to foster a more hospitable global environment for trade. The ability of the United States to play such a leadership role would be enhanced by approval of fast-track negotiating authority. U.S. reliance on the WTO's dispute-settlement mechanism to resolve trade disputes, rather than pursuing unilateral actions, has supported the WTO's rules-based approach to international trade. The IMF staff hopes that the United States and the authorities in other countries will continue to seek cooperative solutions in recent high-profile disputes, refrain from resorting to restrictive trade measures, and work together to improve the dispute-settlement mechanism.
12. Under the Administration's FY 2000 budget, official development assistance (ODA) would be held at its recent historically low level of less than 0.1 percentage of GDP over the five-year budget horizon. The IMF staff urges the authorities to raise the priority assigned to ODA and to re-establish the leadership role of the United States in this area, thereby helping to catalyze a resurgence in such assistance worldwide.