Economic Health Check
U.S. Growth Bouncing Back
July 7, 2015
- U.S. growth strengthens, expected to reach 2.5 percent in 2015
- Case for deferring interest rate increase until greater signs of wage or price inflation
- U.S needs to put public finances on sustainable path, address fiscal imbalances
Despite a slowdown in growth during the first few months of 2015, the U.S. economy is strengthening and there are steady gains in job creation, the IMF said in its annual review on the state of the U.S. economy.
According to the report, the U.S economy’s momentum in the first quarter was derailed by unfavorable weather, a sharp contraction in oil sector investment, and the West Coast port strike.
Even with this weaker first quarter, the IMF said that growth this year is projected at 2.5 percent. Barring any negative shocks, the U.S. economy should be able to bounce back to 3 percent by 2016.
Sustained growth over the next two years should return output to its potential by end-2017. However, potential growth—at around 2 percent—is expected to be considerably weaker than pre-crisis levels unless a broad range of structural weaknesses are tackled to raise productivity, create incentives for innovation and capital formation, and boost labor force participation, the report said.
Risks to sustained growth
Risks to the outlook remained broadly balanced but the report highlights several uncertainties ahead.
The stronger dollar is impacting U.S. growth and job creation, as well as weighing on inflation. If the U.S. currency were to appreciate markedly, that could create concerns, including in some emerging market economies, and the potential for a rise in global imbalances.
The housing recovery is not yet on a solid footing. The demand for housing remains depressed although there is potential for pent-up demand, including from millennials, as household incomes rise and job prospects become more secure.
A continued weakening of growth in the rest of the world could suppress U.S. exports and investment in tradable sectors.
A data dependent approach to monetary policy
The U.S. Federal Reserve’s first interest rate increase in almost nine years has been carefully prepared and announced. Nonetheless, regardless of the timing, higher U.S. policy rates could still result in significant market volatility and financial stability consequences that go well beyond U.S. borders.
The IMF report argues waiting to raise rates until there are greater signs of wage or price inflation. Under staff’s macroeconomic outlook, and assuming no surprises to either growth or inflation, such a data-dependent approach would imply keeping the federal funds rate at 0–0.25 percent into the first half of 2016, with a gradual rise in the federal funds rate thereafter.
The report saw merit in enhancing the Fed’s communication toolkit by scheduling press conferences after the Fed’s Federal Open Market Committee meetings and publishing a quarterly monetary report that provides a baseline economic projection, endorsed by the Federal Open Market Committee.
Pockets of financial stability risks
Much has been done over the past several years to strengthen the U.S. financial system. Looking forward, the report stressed the importance of ensuring that this progress—including the legislative advances in the Dodd-Frank Act—is not rolled back.
At this point, the data suggest a system that has pockets of vulnerabilities rather than one containing broad-based financial excesses. Nevertheless, the report noted that these vulnerabilities cannot be ignored.
The recent financial sector assessment (FSAP) has identified an extensive list of reforms to raise the U.S. system’s resilience.
Fiscal policy dysfunction
The inability of the Congress and the Executive Branch to collectively pass a budget and corresponding appropriations bills creates a level of fiscal uncertainty that is damaging to the U.S. economy, the report said. The report warned of the disruption that a government shutdown or a standoff linked to the federal debt ceiling would cause. It noted that such fiscal uncertainties represent important and avoidable risks to growth and job creation that could move to the forefront, once again, in 2015.
Looking forward, U.S. public finances remain on an unsustainable path. The IMF called for a credible plan to address these imbalances, one that includes revenue-enhancing reforms to the tax system, a pension reform that aligns contributions and benefits, and steps to lessen the growth in public healthcare costs.
Such a plan could provide some modest, near-term fiscal space to finance supply-side measures that support growth, job creation, and productivity.