IMF Executive Board Concludes 2013 Article IV Consultation with the United StatesPress Release No. 13/277
July 26, 2013
The U.S. recovery has remained tepid, with GDP growing at a modest 2.2 percent in 2012, reflected legacy effects from the financial crisis, budget deficit reduction, a weak external environment, and temporary effects of extreme weather-related events.
While policymakers in Congress averted the fiscal cliff at the beginning of 2013, the expiration of the payroll tax cut and implementation of across-the-board spending cuts (“sequester”) are weighing significantly on growth this year, with growth in the first quarter of 2013 at 1.8 percent and indicators suggesting slower growth in the second quarter.
Despite these powerful headwinds, the nature of the recovery appears to be changing. In particular, equity valuations have soared in 2013 and house prices have increased by more than 10 percent over the last 12 months, strengthening household balance sheets and supporting private demand. At the same time, residential construction has accelerated and labor market conditions have improved. To a large extent this owes to very easy financial conditions, with the Fed continuing to add monetary policy accommodation over the past year. Financial conditions have somewhat tightened since mid-May 2013, after the Fed indicated that its asset purchases could be scaled back later in the year, but still remain extremely accommodative. While the rapid pace of fiscal consolidation is expected to keep growth subdued at 1.7 percent in 2013, we expect economic activity to accelerate to 2.7 percent next year as the fiscal drag subsides and the negative legacies of the financial crisis wane further. The unemployment rate is expected to remain broadly stable in 2013, reflecting the pickup in the labor force participation as discouraged workers return to the labor force, and to gradually fall in 2014. Inflation is expected to pick up somewhat but to remain below the Fed long-run objective of 2 percent, given the lingering slack in the economy.
The risks to the outlook appear modestly tilted to the downside. Economic activity could be lower than in our baseline scenario in the presence of a stronger-than-projected impact of fiscal consolidation, a faster-than-expected increase in interest rates, a weaker external environment, or higher structural unemployment. In contrast, the recovery could be stronger than we anticipate if the rebound of the housing market were to ignite a positive feedback loop between higher house prices, easier mortgage conditions, and stronger consumption and investment.
With regard to policy actions, the Federal Reserve has appropriately indicated that it intends to maintain a high degree of monetary policy accommodation for a considerable time after the economy strengthens, and that the pace and composition of its asset purchases will depend on the evolution of economic conditions. The administration’s budget proposal envisages a gradual reduction in the budget deficit so as to put the public debt ratio on a downward path, although political gridlock in Congress makes prospects for legislative action unclear. U.S. banks’ health has improved significantly over the past 12 months, but there are a few signs of emerging vulnerabilities in the financial sector from persistently low interest rates. Further progress was made on strengthening financial regulation, including introducing rules that adopt Basel III capital standards, designating two systemically-important nonbank financial institutions, and proposing a reform of the money market mutual funds industry.
Executive Board Assessment
Executive Directors welcomed the improvement in the underlying conditions of the U.S. economy, which bodes well for a gradual acceleration of growth, while noting that the balance of risks to the outlook remains tilted to the downside.
Directors generally concurred that the fiscal deficit reduction in 2013 is excessively rapid, and that the automatic spending cuts (“the sequester”) not only reduce growth in the short term but could also lower medium-term potential growth. They stressed the importance of adopting a comprehensive and back-loaded medium-term plan entailing lower growth in entitlement spending and higher revenues. Together with a slower pace of deficit reduction in the short run, this fiscal strategy would help sustain global growth, place the U.S. fiscal position on a sustainable path over the medium term, and support the reduction of global imbalances. In this context, a few Directors also expressed concerns regarding the budgetary process and saw room for improvement.
Directors broadly agreed that accommodative monetary policy continues to provide essential support to the recovery, but cautioned that its financial stability implications should be carefully assessed. They considered that a long period of exceptionally low interest rates could potentially entail unintended consequences for domestic financial stability and has complicated the macro-policy environment in some emerging markets. In this context, Directors stressed that strong macro-prudential oversight and supervision of the financial system remain essential.
Directors noted that the Federal Reserve has a range of tools to manage the normalization of monetary policy, but that there are significant challenges involved in unwinding accommodation, including risks of market reactions leading to excessive interest rate volatility that could have adverse global implications. They stressed that effective communication on the exit strategy and a careful calibration of its timing will be critical for reducing these risks.
Directors welcomed the recent improvements in the housing and labor markets. They agreed that the rebound of the housing market has benefited from monetary policy actions and government-backed programs that facilitated refinancing and modification of loans under stress. They saw room for policies that continue to support the housing market while gradually reducing the dominant role of the government-sponsored enterprises. Directors also agreed that the decline in labor force participation and high levels of long-term unemployment suggest room for active labor market policies to complement efforts to boost domestic demand.
Directors noted that while the U.S. banking system is healthier than last year, emerging vulnerabilities and risks from persistently low rates in the financial sector need to be carefully monitored. Directors welcomed the strengthening of the regulatory architecture relative to the pre-crisis period, including through the adoption of Basel III capital rules. They emphasized that completing the implementation of the financial reform agenda remains essential to increase the resilience of the U.S. financial system, while at the same time reducing the risk of regulatory fragmentation at the international level and minimizing negative spillovers.
Directors noted that while the current account deficit has declined, the U.S. external position remains weaker than justified by fundamentals and desirable policies. A gradual but sustained reduction in the fiscal deficit, together with a strengthening of growth in partner countries, would help achieve the desirable strengthening of the current account.