IMF Executive Board Concludes 2009 Article IV Consultation with the United StatesPublic Information Notice (PIN) No. 09/97
July 31, 2009
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2009 Article IV Consultation with the United States is also available.
On July 24, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United States.1
Since the last consultation, the U.S. economy has experienced the worst financial crisis since the Great Depression. In the second half of 2008, financial pressures intensified and came to a head with the failure of Lehman Brothers in September, triggering massive financial instability in U.S. and global financial markets, with severe repercussions for the real economy. In the United States, job losses and the unemployment rate surged, with GDP declining by 6¼ percent in the fourth quarter of 2008 (quarter over quarter, seasonally adjusted annual rate) and a further 5½ percent in the first quarter of 2009. Inflation sank and briefly reached negative territory. Internationally, production and international trade collapsed, with pronounced contractions in manufacturing exporters. Measures of financial stress, especially credit spreads, increased sharply, while Treasury yields fell and the dollar strengthened amid safe-haven flows. Despite the rise in the dollar, the U.S. current account deficit receded on the back of weak domestic demand and lower oil prices.
In response to these shocks, U.S. macroeconomic policy shifted to a war footing. In October 2008, the Troubled Asset Relief Program (TARP) provided capital injections to stressed financial institutions and bolstered financial markets. In addition, guarantees were provided on selected bank assets and liabilities and expanded on deposits. In the same month, the Fed participated in a coordinated rate cut with five other major central banks, and subsequently lowered its target rate to an all-time low range of 0–25 basis points and communicated that conditions were likely to warrant an exceptionally low rate for an extended period. The Fed also enhanced its securities purchases as well as facilities to unfreeze segments of credit markets. In February 2009, the authorities launched a fiscal stimulus of more than 5 percent of GDP over 2009–11 and ramped up support for the housing market. The authorities’ Financial Stability Plan released in February 2009 included stress tests to assess banks’ resilience to the economic downturn, which bolstered confidence in financial stability when results were announced in May, as well as a plan to address toxic assets on financial institutions’ balance sheets.
The combination of massive macroeconomic stimulus and financial market intervention began to stabilize financial and economic conditions. That said, economic activity remains weak, while financial conditions remain somewhat stressed. Looking ahead, financial strains will weigh on investment and (in tandem with the effects of rising unemployment and falling house prices) consumption. In addition, the outlook for partner country growth remains subdued, which will restrain exports.
The medium to longer run will pose a series of major challenges. These include, for the medium term, formulating exit strategies from interventions to stabilize the financial system, as well as extraordinary monetary policy stimulus. For the longer term, challenges include addressing the weaknesses in financial supervision and regulation brought out by the crisis, stabilizing the public finances (particularly in light of rising pressures from entitlements), and coping with an environment of rising saving and slower growth as household balance sheets adjust.
Executive Board Assessment
Executive Directors noted that the U.S. financial and economic crisis has had severe domestic as well as international repercussions on financial stability and growth. Directors commended the authorities’ forceful and internationally coordinated actions to stabilize and repair the financial sector, bolster domestic demand, and address international spillovers. As a result of their increasingly strong and comprehensive policy measures, the sharp fall in economic output seems to be ending, and confidence in financial stability has strengthened. Nevertheless, with financial strains still elevated, the recovery is likely to be gradual, and risks are tilted to the downside. In addition, potential growth could remain well below past trends for a considerable period. Nevertheless, the long-term growth effects expected from structural policies now being implemented were also noted, and a few Directors expected the crisis to have little lasting effect on potential growth, given the flexibility of the economy.
Directors commended the steps taken to stabilize financial conditions and help restore confidence. Policies under the Financial Stability Plan—notably stress tests, debt guarantees, and capital injections—have contributed to a significant improvement in financial conditions. Continued close monitoring and regular stress tests to evaluate vulnerabilities are nevertheless needed. Directors supported implementing expeditiously the resolution framework for systemic nonbank financial institutions, and retaining the proposed reserve for stabilization funds. Balance sheet cleaning remains a priority. More steps might be needed to encourage writedowns of underwater mortgages, but care must be taken to avoid moral hazard.
Directors agreed that macroeconomic policies are providing significant support to demand, and an eventual unwinding would have to wait until an economic recovery is clearly underway. If downside risks materialize, additional credit easing and a strengthened commitment to maintaining a highly accommodative monetary stance could be considered. Additional fiscal stimulus could also be used, although the immediate focus should be on implementing the current fiscal measures and monitoring their impact. Directors welcomed the authorities’ commitment to set policies in a sound medium-term policy framework.
Directors considered that a key priority will be to develop comprehensive exit strategies to unwind the extraordinary crisis-driven interventions, once a sustainable recovery is underway. Directors agreed that the Fed will need a diverse set of tools to respond to the uncertain evolution of market conditions, while the transfer of Maiden Lane facilities to the Treasury would reduce its exposure to credit risk. If extended, the terms of support to financial institutions should be tightened. Directors stressed that clear communication of exit strategies, along with international coordination, would bolster market confidence and facilitate a smooth exit.
Directors welcomed the Administration’s recent proposals for substantial reform and strengthening of financial supervision and regulation. They saw scope for further actions to address fragmentation in the regulatory structure and to clarify the mandate for systemic stability. Some Directors also encouraged consideration of regulations aimed at discouraging size and complexity. Directors supported the authorities’ commitment to an internationally coordinated approach, especially in areas such as crisis management and cross-border supervision. The forthcoming FSAP will provide an opportunity to explore financial supervisory and regulatory issues in more depth.
Directors emphasized that restarting private securitization will be crucial to restore a healthy credit flow. Key steps, some already envisioned in the authorities’ plan, include improving disclosure about the ratings process and underlying credit quality; differentiating ratings for securitized products; strengthening the liability of bundlers to improve their accountability; and encouraging more standardized and simpler securitizations through market codes of conduct. The housing GSEs would need to be subject to strict oversight and regulation, and their role should be clarified as the future shape of the financial system emerges, including whether their liabilities are explicitly guaranteed.
With public debt set to rise substantially over coming years, Directors underscored the need for an ambitious medium-term fiscal consolidation to secure fiscal sustainability, as recognized in the FY2010 budget. As the crisis has exacerbated existing fiscal imbalances, consolidation will likely require significant additional adjustment. Given the low level of discretionary spending, the adjustment would most likely need to focus on the revenue side. Noting the considerable uncertainties surrounding the economic outlook, Directors supported the authorities’ intention to re-evaluate the options for achieving fiscal sustainability if deficits do not decline as expected.
Directors underscored that addressing soaring entitlement costs remains the critical medium-term fiscal challenge. They welcomed the Administration’s focus on health care reform, emphasizing that the ultimate package should include substantial measures to reduce health care costs over the longer term, while aiming at budget neutrality in the short term. Directors underscored that the impact of cost control measures will need to be carefully monitored, and that additional measures should be taken promptly as needed. Directors also welcomed the Administration’s intention to work towards developing a political consensus for social security reform.
Directors observed that the crisis will have important implications for the role of the United States in the global economy. The U.S. consumer is unlikely to play the role of global “buyer of last resort”—suggesting that other regions will need to play an increased role in supporting global growth. Directors welcomed the authorities’ intention to increase foreign aid, and their commitment to maintain an open trade regime during the crisis and, in this context, underscored the importance of resisting protectionism.