## _cr05257 - 1. Major Industrial Countries: Indicators of Economic Performance ## Source details **Canonical URL:** [_cr05257 - 1. Major Industrial Countries: Indicators of Economic Performance](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05257.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05257.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05257.pdf.json) --- ### Executive summary and policy messages - U.S. expansion solidified despite higher world oil prices; robust productivity growth and high corporate profits have supported a strong rebound in business investment and some acceleration in employment. - Policy focus shifted toward removal of stimulus: - The Federal Reserve reversed course in mid-2004 and has since raised the federal funds rate by a cumulative 2¼ percentage points. - The Administration reaffirmed commitment to reducing the budget deficit to below 2 percent of GDP by FY 2009 through rigorous spending restraint, and to making earlier tax cuts permanent. - Key Fund advice and recommended priorities: - Removing macroeconomic stimulus; the pace of interest rate hikes may need to accelerate if inflationary pressures mount. - Adopting a more ambitious fiscal objective to ease burdens on monetary policy and the current account. - Preparing for an aging population by placing the government debt ratio on a clear downward path and undertaking timely reform of Social Security and the health care system. - Maintaining high-productivity growth through tax and other options to enhance saving incentives and improve investment efficiency. - Areas of difference with authorities: - Fund staff called for a more ambitious consolidation aimed at balancing the federal budget excluding Social Security over 5-10 years; authorities adopted a target of reducing the federal deficit to slightly below its long-term average of around 2 percent of GDP by FY 2009. - The Fund urged revenue measures that broaden the tax base and shift burden from income to consumption; authorities resisted, arguing higher taxes would damage efficiency. - Authorities disagree with the Fund on the severity of risks from the large current account deficit. ### Economic developments and financial flows - Growth and productivity: - Real GDP growth: after expanding at a 4½ percent rate in 2004, growth eased to 3¾ percent in Q1 2005. - Officials estimated underlying productivity growth at 2½-3 percent; productivity growth has eased since mid-2004 but remained a key driver. - Inflation and labor market: - Core PCE deflator: just above 1½ percent (12-month rate). - Headline CPI inflation: reached 3½ percent in recent months. - Unemployment rate: dropped to 5.1 percent; participation has fallen. - Weaker productivity growth since mid-2004 contributed to acceleration in unit labor costs. - External balances and financial flows: - U.S. dollar: depreciated by about 15 percent in real effective terms over the past three years. - Current account deficit: increased to 6½ percent of GDP in Q1 2005. - U.S. net international liabilities: estimated to have risen to about 25 percent of GDP. - Foreign savings: provided at record levels; massive capital inflows financed the record current account deficit. - Sectoral financing and saving: - Net lending by the corporate sector: at record highs; businesses used high profits to strengthen balance sheets. - Federal government budget: shifted from a 2½ percent of GDP surplus in FY 2000 to a 3½ percent of GDP deficit in FY 2004. - General government deficit: 4¼ percent of GDP in calendar year 2004. - Household saving rate: fallen to record lows; staff estimate saving rate is currently some 1½-2 percentage points below a level consistent with household income and wealth. ### Short-term outlook and principal risks - Staff baseline scenario assumptions: - Short-term interest rates gradually increase through 2006 and the fiscal balance improves modestly. - Real long-term interest rates and spreads return to more typical values as business investment and national saving rebound, while residential investment growth eases. - Productivity growth decelerates further as economy returns to full employment before settling at 2¼ percent, supporting potential growth of 3¼ percent. - Inflation remains contained as slack is eroded gradually and robust labor productivity growth limits unit labor cost increases. - Baseline projections: - Staff projects growth of 3½ percent in 2005 and 2006. - Under the scenario (assuming an unchanged real effective exchange rate), the current account deficit would remain at over 6 percent of GDP. - Key downside risks: - Sustained high oil prices: Fed officials suggested oil price developments could lower growth by ½-¾ percentage points during 2005. - Sustained slowdown in productivity: could raise cost pressures, shift investor preferences away from U.S. assets, and push up global interest rates and risk premia. - Housing sector froth: house price stagnation could reduce consumption growth by less than 1 percent a year under standard multipliers, but possibly more given very low household saving. ### Quantitative medium-term projections and key indicators (select) - Real GDP (percent changes): 2002: 1.9; 2003: 3.0; 2004: 4.4; 2005: 3.6; 2006: 3.5; 2007: 3.6; 2008: 3.6; 2009: 3.5; 2010: 3.3 - Unemployment rate (percent): 2002: 5.8; 2003: 6.0; 2004: 5.5; 2005: 5.2; 2006: 5.2; 2007: 5.1; 2008: 5.0; 2009: 5.0; 2010: 4.9 - CPI inflation (percent): 2002: 1.6; 2003: 2.3; 2004: 2.7; 2005: 2.9; 2006: 2.5; 2007: 2.5; 2008: 2.5; 2009: 2.5; 2010: 2.5 - Unified federal balance (percent of GDP): 2002: -2.4; 2003: -3.3; 2004: -3.3; 2005: -3.0; 2006: -2.8; 2007: -2.3; 2008: -2.0; 2009: -1.9; 2010: -1.7 - Current account balance (percent of GDP): 2002: -4.5; 2003: -4.8; 2004: -5.7; 2005: -6.2; 2006: -6.1; 2007: -6.1; 2008: -6.1; 2009: -6.1; 2010: -6.0 - Oil prices ($/barrel, simple average): 2002: 25.0; 2003: 28.9; 2004: 37.8; 2005: 50.7; 2006: 53.0; 2007: 51.8; 2008: 50.3; 2009: 49.5; 2010: 49.0 ### Policy recommendations and reform priorities - Monetary policy: Continue gradual removal of stimulus; be prepared to accelerate rate hikes if inflationary pressures build. - Fiscal policy: - Undertake more ambitious fiscal consolidation to place government debt on a clear downward path and prepare for demographic pressures from population aging. - Consider revenue measures that broaden the tax base and shift burden from income to consumption. - Social insurance and health care: Address underfunding in Social Security and Medicare; avoid delaying reforms to reduce future adjustment burden. - Structural policies: Promote policies to sustain high productivity growth, improve saving incentives, and enhance investment efficiency; guard against protectionist pressures. --- ### _cr05257 - 16. Current account outlook and recent developments ### Current account outlook and financing patterns - Officials agreed U.S. current account likely to widen further in 2005 absent a significant pick-up in partner country growth. - Staff analysis: current account deficit appears at least 3 percent of GDP higher than suggested by medium-term fundamentals. - Financing shifts: - Toward fixed income instruments, increasing U.S. liabilities in debt securities. - External financing increasingly dependent on official flows. - International liabilities and income balance: - Larger international liabilities, particularly in debt securities, expected to weaken income balance as U.S. interest rates rise. - Vulnerabilities grow as net foreign asset position deteriorates. ### Factors limiting near-term narrowing of the deficit - Trade elasticities: income elasticity of U.S. import demand typically larger than foreign demand for U.S. goods. - Openness and trade shares: - Exports represent only 10 percent of GDP; with imports half again as large, exports must grow much faster than imports to keep deficit unchanged. - Pass-through and trade patterns: - Pass-through may have fallen over time, reducing impact of exchange rate depreciation on trade balance. - China’s weight in U.S. REER weights doubled from around 5 percent to over 10 percent between 1995 and 2002. - Exchange rate and competitiveness: - Fed’s broad CPI-based REER is above its estimated value using a modified PPP approach. - Staff analysis suggests U.S. dollar remains significantly overvalued. - Fiscal linkages: - Fed estimate: deficit reduction of 1 percent of GDP would lead to only a 0.2 percentage point increase in the current account balance. - Staff simulations suggest a permanent change in fiscal balance generates a significant current account improvement. ### Views on risk of a disorderly adjustment - Officials downplayed Fund concerns about a “disorderly adjustment,” citing: - U.S. economic strength and large, liquid financial markets. - Absence of more attractive destinations for global capital. - Recent strengthening of the dollar and brisk foreign demand for U.S. corporate bonds. - Fed officials agreed a significant depreciation of the dollar would be needed to narrow the trade balance and stabilize the net investment position; dollar-denomination of U.S. foreign liabilities means revaluation would work in favor of U.S. residents. ### Box 2 findings: Why has the U.S. trade balance deteriorated so fast? - Despite a 15 percent real effective depreciation since early 2002, the U.S. trade deficit widened rapidly. - Two muting factors: - Declining exchange rate pass-through due to competition from low-cost countries. - Rapidly changing trade patterns (notably China’s rising weight) could lead to overestimation of measured gains in competitiveness. - Staff conclusion: U.S. dollar remains significantly overvalued; U.S. exports have lost some market share in recent years. ### Policy discussion — fiscal consolidation and rationale - Authorities aimed to bring federal fiscal deficit below 2 percent of GDP by FY 2009. - FY 2004 deficit: 3½ percent of GDP; FY 2005 outcome could be under 3 percent of GDP. - Mission assessment: progress toward consolidation principally cyclical rather than structural; structural primary balance close to historic lows; budget implied only a modest 1½ percent of GDP improvement over next five years. - Staff recommendation: eliminate the deficit excluding the Social Security surplus by early in the next decade—an improvement of roughly 4 percent of GDP relative to staff baseline. - Rationale for early substantial fiscal effort: - Cyclical: reduce fiscal deficit by roughly 1 percent of GDP per annum to ease burden on monetary policy without unduly dragging short-term activity. - Low national saving and large external deficit: a 4 percent of GDP permanent improvement raises national saving by some 3 percent of GDP over 5 years and reduces external deficit by almost 2 percent of GDP. - Global policy coordination: decisive U.S. fiscal consolidation could catalyze bolder action by other countries. - Long-term sustainability: essential to place government debt on a downward path, improve intergenerational fairness, and allow time to develop and phase in health and retirement reforms. --- ### _cr05257 - 28. Fiscal stance, entitlement pressures, and saving ### Fiscal stance, short-term objectives, and revenue - Officials agreed raising national saving was important, but saw no need to strengthen their fiscal objective. - Administration progress: framework for identifying expenditure priorities and improving spending efficiency to yield savings. - Officials emphasized revenue enhancements could spur higher spending; key to fiscal sustainability was reform of entitlement programs rather than a more ambitious near-term deficit target. - Mission view: fiscal sustainability likely requires revenue measures; Presidential Advisory Panel on Federal Tax Reform charged to report on simplifying and improving tax system in a revenue-neutral manner (baseline included AMT revenues). - Administration preferred PAYGO apply only to expenditure, viewing revenue offsets as potential encouragement to tax-financed spending increases. ### Long-term fiscal sustainability and entitlement magnitudes - Actuarial liability of Social Security over next 75 years: 30 percent of GDP. - Estimated unfunded liability of Medicare: 200 percent of GDP, one-third from prescription drug benefit enacted in 2003. - Medicare and Medicaid: together finance half of all U.S. health care outlays. - U.S. spends almost twice as much on health care as ratio to GDP than other OECD countries. - Actuarial assumption: per-beneficiary spending grows at 1 percentage point a year above per-capita GDP growth; recent excess has been 2–2½ percent, which would approximately double unfunded liability over 75 years. ### Medicare and Medicaid structure and FY 2006 proposals - Medicare outlays total some 2½ percent of GDP, comprising: - Hospital insurance (HI): funded by 2.9 percent payroll tax; currently running a small surplus (¼ percent of GDP); HI deficits projected from 2018; trust fund exhausted by 2030. - Supplemental Medical Insurance (SMI): about one-quarter of costs funded by premiums; balance from general government revenues. - Prescription drug coverage: legislated in 2003; benefits available January 1, 2006; only about 25 percent of program costs covered by premiums; standard basic coverage cost estimated at $593 billion over 2004-2013 by CBO. - Medicaid: federal government pays 50 to 77 percent of state Medicaid expenses; total Medicaid outlays comprise over 2½ percent of GDP. - FY 2006 Budget proposals: further shift fiscal responsibility for Medicaid to states, reducing federal financing by about $45 billion over ten years; replace cost-sharing with block grants indexed to CPI; streamline financing vehicles and cap payments to hospitals and nursing homes. ### Social Security reform and PRAs - President endorsed “progressive indexing,” linking future increases in initial benefits to a sliding combination of wage and price indexes; officials stated this would eliminate some 70 percent of system’s unfunded liabilities while preserving replacement ratios for low-income workers. - Progressive indexing, if coupled with other reforms (e.g., increasing statutory retirement age), would close 75-year actuarial gap and yield positive cash flow at end of 75-year period. - Personal Retirement Accounts (PRAs): permit younger workers to shift up to 4 percentage points of Social Security contributions into PRAs, coupled with equivalent reduction (in net present value terms) in future benefits. - PRAs would cause significant increase in federal deficits and debt over several decades as implicit liabilities are recognized and transitional costs borne, with likely marginal direct impact on national saving and financial markets. - Team cautioned PRAs should be coupled with measures to ensure long-term solvency and not introduced without measures to eliminate unfunded liabilities. ### Tax reform, national saving, and structural advice - Mission cautioned importance of raising national saving to support capital accumulation and buttress labor productivity as TFP growth likely moderates and working-age population slows. - Officials emphasized raising personal saving rate was core objective of tax-reform plans: tax rates lowered on dividends and capital gains; Administration supported elimination of double taxation of returns to saving. - FY 2006 budget proposals: consolidate, simplify, and extend tax-preferred saving schemes; strengthen incentives for saving; bolster corporate pension regulations; place public pension system on sustainable footing. - Mission cautioned fiscal incentives most effective in raising national saving if fully financed; reducing double taxation of capital income would not necessarily raise national saving unless revenue losses were offset. - Tax system characteristics: - U.S. tax system: higher statutory tax rates and lower revenue yields than OECD average, reflecting widespread personal and corporate income tax preferences. - Preferences account for about 40 percent of potential tax revenue, including preferences for employer-provided medical insurance, pension contributions, and charitable giving. - Housing tax benefits (mortgage interest deductibility, treatment of property taxation, capital gains): most generous in G-7 and help explain high ratio of U.S. residential to business investment. - Mission noted possibility of a federal VAT or sales tax could improve efficiency by shifting burden from income to consumption and help intergenerational equity; energy taxation also raised as a revenue option though not covered by Advisory Panel mandate. --- ### _cr05257 - 42. Financial sector resilience, supervision, trade policy, and staff appraisal ### Financial sector resilience and supervisory issues - U.S. financial sector "remains resilient and well regulated." - Supervisory observations: - Increase in interest rate spreads, particularly on high yield instruments, from surprisingly low earlier levels. - Consumer business major source of bank revenues: strong gains from home-equity loans and mortgage servicing offset slower growth of credit card loans and mortgage originations. - Housing-market correction risk judged "relatively low" nationally despite regional froth and increased use of riskier mortgage products. - Loan portfolios well diversified geographically. - Supervisory agencies close to finalizing guidance requiring banks to strengthen risk management regarding riskier mortgage products. - Basel II: officials noted timetable for implementing Basle II "could be missed" due to need to analyze large effects on capital ratios from bank self-assessments. - Corporate governance: Sarbanes-Oxley reform "progressed smoothly"; compliance-cost concerns expected to diminish. - GSEs: mission supported plans for independent regulator; limits on size of GSE portfolios; regulator to set capital requirements, stress tests, and receivership authority; draft legislation lacked adequate measures to limit GSE portfolio size. - Corporate pension reform: mission welcomed proposals to strengthen funding incentives and disclosure given large unfunded liabilities in defined benefit plans. - Insurance supervision: despite irregularities, officials maintained state supervision adequate; federal-state supervisory relationships described as strong. - Mortgage lending standards: regulatory moves to tighten standards described as "appropriate." ### Trade policy, Doha Round, and protectionism - Doha Round: authorities welcomed progress but cautioned key issues unresolved; priorities include sharp reductions in agricultural tariffs, minimizing sheltered product lists, and progress on non-agricultural market access and services. - WTO services negotiations: officials hoped for "higher-quality offers," particularly from developing countries; U.S. flexibility constrained by immigration and security concerns. - U.S. FTAs: reiterated as effective means for promoting multilateral liberalization; mission stressed ensuring FTAs do not undermine multilateral non-discrimination. - Protectionist sentiment: staff concerned about rising protectionist sentiment in Congress; officials cautioned it would be difficult to contain without changes in Chinese exchange rate policy. - Safeguard measures introduced on seven textile products in May following quota expirations; officials emphasized compatibility with China’s WTO accession protocol. ### Official development assistance - ODA/GNI ratio: jumped to 0.16 percent in 2004, up from 0.11 in 2001; partly reflected spending on Iraq and Afghanistan. - Administration committed to maintaining USAID assistance as Millennium Challenge Account became operational. ### Staff appraisal: macro outlook and policy priorities - Growth and inflation: - U.S. "main locomotive of global growth"; nearer term prospects broadly favorable. - Pace of expansion "has eased somewhat"; household saving rate concerns remain. - Growth expected to "remain slightly above trend"; inflation pressures appear contained despite higher oil prices. - U.S. expected to "outperform the rest of the G-7 in 2005." - External imbalances and fiscal risks: - Heavy reliance on foreign saving and large fiscal deficit contributed to global imbalances and systemic risk concerns. - Critical priority: "ambitious fiscal consolidation coupled with measures to ensure the long-term sustainability of public health and retirement systems," structural reforms, and greater exchange rate flexibility abroad. - Monetary policy: - Federal Reserve’s gradual and flexible tightening effective; communication anchored expectations. - Monetary conditions still appear accommodative; a more aggressive pace of rate hikes cannot be ruled out given low unemployment, rise in unit labor costs, and house price inflation. - Fiscal policy, entitlements, and reform recommendations: - Administration’s deficit reduction call "welcome," but "more ambitious efforts appear warranted." - Recommendation: "Achieving a balanced budget excluding Social Security early in the next decade." - Revenue options: broaden income tax base by curbing deductions (e.g., mortgage interest) or tax consumption more directly (national consumption or energy tax). - Recommend legislated budget rule and re-authorization of BEA provisions, including pay-as-you-go covering revenue measures. - Health care: - "Medicare outlays are on an unsustainable path." - Projections: public health care outlays projected to triple as ratio to GDP in coming decades absent reforms. - Social Security: - Encouraging steps taken; PRAs would not place the system on a sustainable basis and would significantly raise federal deficits and debt in coming decades unless combined with comprehensive solvency measures. - Encouraging saving: - Structural reforms and policies to promote default participation in retirement plans recommended to support saving and private risk management. --- ### APPENDIX III & External-sector VAR: debt sustainability, shocks, and model simulations ### Methodology (appendix) - Baseline trajectories for public and external debt set using staff-projected macro variables per “Assessing Sustainability” methodology. - Fiscal and external baselines subjected to two-standard deviation shocks in: domestic interest rates, real growth, inflation, real exchange rates, primary fiscal deficit (government debt only), non-interest current account (external debt only). - Shocks last two years, except a flow-of-liabilities shock lasting one year. - Net general government debt defined as net financial liabilities of federal, state, and local government to the public (excluding social insurance trust funds). - Gross external liabilities used as stock of external financing. - Alternative stress tests use VAR to estimate impacts and construct 95 percent confidence interval from shocks in growth, inflation, short- and long-term interest rates, general government fiscal balance, and REER. ### Key public debt findings - In all but one case, shocks initially boost public debt, then debt resumes baseline downward trend. - Two-year shocks in interest rate, primary balance, REER, and one-year flow-of-liabilities shock show no persistence in net government debt-to-GDP after first two years. - Only a shock to real growth presents a persistence problem requiring alternative actions. - VAR analysis: a persistent one standard deviation increase in short-term interest rates initially accelerates debt accumulation faster than similarly calibrated higher inflation or lower growth, then stabilizes with debt at 69 percentage points of GDP. - VAR-based 95 percent confidence interval suggests uncertainty of around +/- 5 percentage points of GDP after 5 years for government debt path. ### Key external debt findings - U.S. external debt resilient to shocks in real growth and domestic prices; first-two-year shocks raise external debt ratio, then it resumes baseline trend. - Interest rate shock initially raises external debt level, but following the shock external debt levels then rise slower than in other scenarios including the baseline. - VAR on net IIP finds persistent REER shocks could marginally worsen U.S. debt position, while higher inflation or lower growth may actually improve it. - VAR estimates 95% confidence interval of +/- 6 percentage points of GDP in the fifth year for net IIP. ### Selected debt sustainability figures (public sector and external) - Public sector debt (percent of GDP): 2000: 57.1; 2001: 56.6; 2002: 58.6; 2003: 60.5; 2004: 61.0; 2005: 61.9; 2006: 62.7; 2007: 62.9; 2008: 62.9; 2009: 62.6; 2010: 62.3 - External debt (percent of GDP): 2004: 101.8; 2005: 107.9; 2006: 114.0; 2007: 120.0; 2008: 126.0; 2009: 131.9; 2010: 137.7 - Current account deficit excluding interest payments (percent of GDP): 7.5, 6.3, 6.9, 7.1, 8.5, 8.8, 9.6, 10.1, 10.5, 10.5, 10.7 (series aligned with appendix table) - External debt-to-exports ratio (percent, selected): 2000: 83.8; 2001: 91.4; 2002: 93.9; 2003: 103.0; 2004: 104.1; 2005: 105.3; 2006: 106.9; 2007: 109.4; 2008: 112.3; 2009: 114.7; 2010: 116.9 ### Alternative scenarios, bound tests, and extreme outcomes - Country-specific one-standard-deviation GDP reduction in 2005 yields public sector debt series (selected): 61.9, 62.7, 62.9, 62.9, 62.6, 62.3, 0.7 (table entries preserved as in source). - One-time 30 percent real depreciation in 2005 produces similar reported public sector debt outcomes. - External-bound tests (B1–B6) show alternative external debt trajectories; external debt percent of GDP could rise to as high as 143.4 under B2 and 141.6 under B5 combination scenarios. ### Impact of Fund policy advice (Global Fiscal Model simulation) - Simulated policy: permanent 4 percent of GDP improvement in fiscal deficit, building over 5 years via labor tax increases raising fiscal balance by 1 percentage point of GDP a year between 2006 and 2009. - Real activity impact (percent change from policy baseline): Real GDP: 2006 -0.3; 2007 -0.6; 2008 -0.9; 2009 -0.9; 2010 -0.7 - Fiscal and external outcomes (cumulative or level impacts): - Federal budget balance (levels as ratio to GDP): 2006 1.0; 2007 2.0; 2008 3.0; 2009 4.0; 2010 4.0 - Federal debt (cumulative impact, ratio to GDP): 2006 -1.0; 2007 -3.0; 2008 -5.8; 2009 -9.5; 2010 -13.2 - Current account (levels as ratio to GDP): 2006 0.5; 2007 1.0; 2008 1.7; 2009 1.9; 2010 2.0 - Net foreign assets (cumulative impact, ratio to GDP): 2006 0.5; 2007 1.5; 2008 3.1; 2009 4.9; 2010 6.7 - Real exchange rate (percent change): 2006 -1.9; 2007 -3.6; 2008 -5.4; 2009 -5.3; 2010 -5.1 - Net results by 2010: - Government debt is some 13 percentage points below its baseline value. - Net foreign assets are some 7 percentage points of GDP higher. --- ### _cr05257 - 1 (Supplement): recent information since staff report and PIN (July 2005) ### Recent economic and market developments - Labor and activity: - June payroll employment rose by 146,000 (1¼ percent annualized). - Unemployment rate fell 0.1 percentage points to 5 percent. - Industrial production increased by 0.9 percent (month-on-month). - Retail sales increased by 1.7 percent (month-on-month). - Trade deficit fell to $55.3 billion in May from $56.9 billion in April. - Inflation and bond markets: - June 12-month overall CPI: 2.5 percent. - June 12-month core CPI: 2.1 percent. - Headline PPI: 3.6 percent; core PPI: 2.2 percent. - Spreads between conventional and inflation-indexed 10-year bonds: around 2¼ percent. - Financial market responses: - Long-term bond yields increased by about ¼ percentage point to around 4¼ percent. - Market expects a further 75 basis points of Fed tightening by end-2005. - Stock prices strengthened; dollar returned to June level after early July appreciation. ### Fiscal and legislative updates - Administration’s Mid-Session Review lowered projected unified deficit for FY 2005 to $333 billion (2¾ percent of GDP), compared with February estimate of $412 billion (3½ percent of GDP). - Unified federal deficit projected to remain at 2¾ percent of GDP in FY 2006 and fall to almost 1 percent of GDP by FY 2010, including costs from assumed PRAs in FY 2009 and FY 2010. - Legislative status: - No consensus in Congress on Social Security reform or PRAs; debate postponed until after August recess. - Reconciliation of energy bills underway. - Corporate pension reform bill on track for House vote. - Central America Free Trade Agreement passed Senate; pending House vote. ### PIN and Executive Board assessment (July 22, 2005) — select views - Staff projects growth of 3½ percent in 2005 and 2006. - Current account deficit: rose to a record 6½ percent of GDP in Q1 2005; under unchanged REER assumption, would remain over 6 percent of GDP. - U.S. net international liabilities: estimated to have risen to over 20 percent of GDP. - Household saving rate: staff estimates some 1½-2 percentage points below level consistent with income and wealth. - Executive Directors’ key recommendations: - More ambitious fiscal consolidation using current cyclical strength; most Directors considered Administration’s goal of halving the deficit relatively unambitious. - Explore revenue enhancements (broadening income tax base or taxing consumption more directly) to support deficit reduction without undoing tax rate cuts. - Early legislative action to eliminate Social Security and Medicare funding shortfalls. - Commend Fed’s gradual tightening; a clearer inflation objective suggested by a few Directors. - Structural reforms to support saving and high productivity; promote default participation in retirement plans. - Resist protectionist pressures; encourage progress in Doha Round. - Encourage further increases in U.S. ODA given low ODA/GNI ratio. * _cr05257 - 1. Major Industrial Countries: Indicators of Economic Performance (IMF Country Report excerpt)._ ### 1. Major Industrial Countries: Indicators of Economic Performance..............................40 ### _cr05257 - 1. Major Industrial Countries: Indicators of Economic Performance..............................40 ### Executive summary and policy messages - The U.S. expansion solidified during the past year despite higher world oil prices; robust productivity growth and high corporate profits have supported a strong rebound in business investment and some acceleration in employment. - Policy focus has shifted toward removal of stimulus: - The Federal Reserve reversed course in mid-2004 and has since raised the federal funds rate by a cumulative 2¼ percentage points. - The Administration has reaffirmed its commitment to reducing the budget deficit to below 2 percent of GDP by FY 2009 through rigorous spending restraint, and to making earlier tax cuts permanent. - Key Fund advice and recommended priorities: - Removing macroeconomic stimulus; the pace of interest rate hikes may need to accelerate if inflationary pressures mount. - Adopting a more ambitious fiscal objective to ease burdens on monetary policy and the current account. - Preparing for an aging population by placing the government debt ratio on a clear downward path and undertaking timely reform of Social Security and the health care system. - Maintaining high-productivity growth through tax and other options to enhance saving incentives and improve investment efficiency. - Areas of difference with authorities: - Fund staff called for a more ambitious consolidation aimed at balancing the federal budget excluding Social Security over 5-10 years; authorities adopted a target of reducing the federal deficit to slightly below its long-term average of around 2 percent of GDP by FY 2009. - The Fund urged revenue measures that broaden the tax base and shift burden from income to consumption; authorities resisted, arguing higher taxes would damage efficiency. - Authorities disagree with the Fund on the severity of risks from the large current account deficit. ### Economic developments and financial flows - Growth and productivity: - After expanding at a 4½ percent rate in 2004, real GDP growth eased to 3¾ percent in the first quarter of 2005. - Productivity growth has eased since mid-2004 but remained a key driver; officials estimated the underlying rate of productivity growth at a healthy 2½-3 percent. - Inflation and labor market: - The core deflator for personal consumption expenditure stands at just above 1½ percent (12-month rate). - Headline CPI inflation has reached 3½ percent in recent months. - The unemployment rate dropped to 5.1 percent; participation has fallen. - Weaker productivity growth since mid-2004 has contributed to acceleration in unit labor costs. - External balances and financial flows: - The U.S. dollar depreciated by about 15 percent in real effective terms over the past three years. - The current account deficit increased to 6½ percent of GDP in the first quarter of 2005. - U.S. net international liabilities are estimated to have risen to about 25 percent of GDP. - Foreign savings are being provided at record levels; massive capital inflows have financed the record current account deficit. - Sectoral financing and saving: - Net lending by the corporate sector is at record highs; businesses have used high profits to strengthen balance sheets. - The federal government budget shifted from a 2½ percent of GDP surplus in FY 2000 to a 3½ percent of GDP deficit in FY 2004. - General government deficit was 4¼ percent of GDP in calendar year 2004. - The household saving rate has fallen to record lows; staff estimate the saving rate is currently some 1½-2 percentage points below a level consistent with household income and wealth. ### Short-term outlook and principal risks - Staff baseline scenario assumptions: - Short-term interest rates gradually increase through 2006 and the fiscal balance improves modestly. - Real long-term interest rates and spreads return to more typical values as business investment and national saving rebound, while residential investment growth eases. - Productivity growth decelerates further as the economy returns to full employment before settling at 2¼ percent, supporting potential growth of 3¼ percent. - Inflation remains contained as slack is eroded gradually and robust labor productivity growth limits unit labor cost increases. - Baseline projections: - The staff projects growth of 3½ percent in 2005 and 2006, slightly above potential and close to the consensus forecast. - Under the scenario (assuming an unchanged real effective exchange rate), the current account deficit would remain at over 6 percent of GDP. - Key downside risk factors noted by authorities and staff: - Sustained high oil prices: Federal Reserve officials suggested recent oil price developments could lower growth by ½-¾ percentage points during 2005. - A sustained slowdown in productivity could raise cost pressures, shift investor preferences away from U.S. assets, and push up global interest rates and risk premia. - Signs of “froth” in the housing sector in some regions; staff view house price stagnation as the most likely scenario, which could reduce consumption growth by less than 1 percent a year under standard multipliers, but possibly more given very low household saving. ### Quantitative medium-term projections and key indicators (percent changes or levels as indicated) - National production and income (Percent changes from previous period, unless otherwise indicated) - Real GDP: 2002: 1.9; 2003: 3.0; 2004: 4.4; 2005: 3.6; 2006: 3.5; 2007: 3.6; 2008: 3.6; 2009: 3.5; 2010: 3.3 - Total domestic demand: 2002: 2.5; 2003: 3.3; 2004: 4.8; 2005: 4.0; 2006: 3.5; 2007: 3.5; 2008: 3.5; 2009: 3.4; 2010: 3.3 - Final domestic demand: 2002: 2.1; 2003: 3.4; 2004: 4.4; 2005: 3.8; 2006: 3.3; 2007: 3.4; 2008: 3.5; 2009: 3.4; 2010: 3.3 - Private final consumption: 2002: 3.1; 2003: 3.3; 2004: 3.8; 2005: 3.7; 2006: 3.4; 2007: 3.3; 2008: 3.5; 2009: 3.1; 2010: 3.0 - Net exports (contribution): 2002: -0.7; 2003: -0.4; 2004: -0.6; 2005: -0.6; 2006: -0.1; 2007: -0.1; 2008: 0.0; 2009: -0.1; 2010: -0.1 - Unemployment rate (percent): 2002: 5.8; 2003: 6.0; 2004: 5.5; 2005: 5.2; 2006: 5.2; 2007: 5.1; 2008: 5.0; 2009: 5.0; 2010: 4.9 - CPI inflation: 2002: 1.6; 2003: 2.3; 2004: 2.7; 2005: 2.9; 2006: 2.5; 2007: 2.5; 2008: 2.5; 2009: 2.5; 2010: 2.5 - Unified federal balance (levels, in percent of GDP): 2002: -2.4; 2003: -3.3; 2004: -3.3; 2005: -3.0; 2006: -2.8; 2007: -2.3; 2008: -2.0; 2009: -1.9; 2010: -1.7 - Current account balance (levels, in percent of GDP): 2002: -4.5; 2003: -4.8; 2004: -5.7; 2005: -6.2; 2006: -6.1; 2007: -6.1; 2008: -6.1; 2009: -6.1; 2010: -6.0 - Memorandum items: - Partner country growth: 2002: 2.2; 2003: 1.7; 2004: 3.3; 2005: 2.5; 2006: 2.8; 2007: 3.0; 2008: 2.9; 2009: 2.9; 2010: 2.8 - Oil prices ($/barrel) (Average petroleum spot price: simple average of U.K. Brent, Dubai, and West Texas prices): 2002: 25.0; 2003: 28.9; 2004: 37.8; 2005: 50.7; 2006: 53.0; 2007: 51.8; 2008: 50.3; 2009: 49.5; 2010: 49.0 ### Policy recommendations and reform priorities - Monetary policy: Continue gradual removal of stimulus; be prepared to accelerate rate hikes if inflationary pressures build. - Fiscal policy: Undertake more ambitious fiscal consolidation to place government debt on a clear downward path and to prepare for demographic pressures from population aging; consider revenue measures that broaden the tax base and shift burden from income to consumption. - Social insurance and health care: Address underfunding in Social Security and Medicare; avoid delaying reforms to reduce the future adjustment burden. - Structural policies: Promote policies to sustain high productivity growth, improve saving incentives, and enhance investment efficiency; guard against protectionist pressures stemming from trade imbalances that could undermine multilateral trade negotiations. * _cr05257 - 1. Major Industrial Countries: Indicators of Economic Performance..............................40 (IMF Country Report excerpt)._ ### 16. Officials agreed that the U.S. current account was likely to widen further in 2005 in ### _cr05257 - 16. Officials agreed that the U.S. current account was likely to widen further in 2005 in ### Current account outlook and recent developments - Officials agreed the U.S. current account was likely to widen further in 2005 in the absence of a significant pick-up in partner country growth. - The current account has widened despite the dollar's depreciation; staff analysis suggests the current account deficit appears at least 3 percent of GDP higher than suggested by medium-term fundamentals. - Financing patterns: - Financing has shifted toward fixed income instruments, increasing U.S. liabilities in debt securities. - U.S. external financing has become increasingly dependent on official flows. - External position dynamics: - Larger international liabilities, particularly in debt securities, are expected to weaken the income balance of the current account as U.S. interest rates rise, increasing the trade-balance correction needed to stabilize the U.S. net international investment position. - Vulnerabilities continue to grow as the net foreign asset position deteriorates. ### Factors limiting prospects for near-term narrowing of the deficit - Trade elasticities: - The income elasticity of U.S. demand for imports is typically estimated to be significantly larger than that of foreign demand for U.S. goods. - Openness and trade shares: - Exports represent only 10 percent of GDP and, with imports half again as large, export volumes must grow significantly faster than imports simply to keep the deficit unchanged. - Pass-through and changing trade patterns: - Recent analyses at the Fed and the Fund suggest that pass-through may have fallen over time, possibly reflecting changing trade patterns, reducing the impact of exchange rate depreciation on the trade balance. - Geographic evidence: prices of imports from Canada and Europe responded similarly to exchange rate changes as in the past, while changes involving China may differ. - China’s weight in U.S. real effective exchange rate weights doubled from around 5 percent to over 10 percent between 1995 and 2002. - Exchange rate and competitiveness: - The Fed’s broad CPI-based real effective exchange rate is above its estimated value using a modified purchasing power parity approach. - Staff analysis suggests the U.S. dollar remains significantly overvalued. - Empirical links to fiscal policy: - The Federal Reserve has estimated that a deficit reduction of 1 percent of GDP would lead to only a 0.2 percentage point increase in the current account balance. - Staff simulations (Appendix IV and Chapter 5 of the Selected Issues paper) suggest a permanent change in the fiscal balance generates a significant current account improvement. ### Views on the risk of a disorderly adjustment - Officials tended to downplay the Fund’s concerns about a “disorderly adjustment,” citing: - The United States’ economic strength and large, liquid financial markets. - Absence of more attractive destinations for global capital. - Recent strengthening of the dollar and brisk foreign demand for U.S. corporate bonds. - Analysis suggesting global investment portfolios were generally not overweight in U.S. assets. - Fed officials agreed that a significant depreciation of the dollar would be needed to narrow the trade balance and stabilize the net investment position; however, the dollar denomination of U.S. foreign liabilities means revaluation of wealth would work in favor of U.S. residents. ### Box 2 findings: Why has the U.S. trade balance deteriorated so fast? - Despite the dollar’s 15 percent real effective depreciation since early 2002, the U.S. trade deficit widened rapidly. - Two factors that may have muted the impact of the dollar’s fall: - Declining exchange rate pass-through due to higher competition from low-cost producing countries, reducing import-price responsiveness to exchange rate movements. - Rapidly changing trade patterns (notably China’s rising weight) could lead to an overestimation of measured gains in U.S. external competitiveness; deviations from purchasing power parities could significantly reduce the measured gain. - Staff conclusion in Box 2: the U.S. dollar remains significantly overvalued; U.S. exports have lost some market share in recent years. ### Policy discussions — monetary policy - Monetary tightening since mid-2004: - Federal Reserve raised the federal funds rate by 25 basis points at each meeting since June 2004, to 3¼ percent. - Overnight rates had been kept at 1 percent for over a year prior to the tightening cycle. - Fed stance and communication: - Fed officials saw the withdrawal of accommodation as appropriately balancing price stability and growth, shifting attention to inflation over the past year. - Real short-term interest rates remained around zero; extremely low long-term rates suggested market participants might be discounting future rate hikes. - Officials emphasized a “risk management” approach and praised the FOMC’s skillful communication to avoid repeating the 1994 experience. - Consideration of an explicit inflation objective: - Staff suggested a more explicit long-term inflation objective could further anchor expectations and long-term bond yields. - Officials noted the Fed’s dual mandate (price stability and maximum employment) and concern that quantifying the inflation objective could constrain the Committee’s room for maneuver. - Box 3 evidence: comparisons with Canada and the United Kingdom suggest an explicit definition of price stability might help reduce volatility in bond markets and inflation expectations. ### Policy discussions — fiscal consolidation and recommendations - Fiscal developments and targets: - Authorities aimed to bring the federal fiscal deficit below 2 percent of GDP by FY 2009. - FY 2004 deficit came in at 3½ percent of GDP—1 percentage point better than expected. - FY 2005 outcome could be under 3 percent of GDP; FY 2006 prospects boosted by Congress’ budget resolution. - Mission assessment: - Progress toward fiscal consolidation appears to reflect principally cyclical rather than structural gains. - The structural primary balance remained close to historic lows; the budget implied only a modest 1½ percent of GDP improvement over the next five years. - Medium-term budget projections assume unprecedented compression of nondefense discretionary spending and do not account for funding for operations in Iraq and Afghanistan after FY 2006 or pressures from the Alternative Minimum Tax. - Staff recommendations and scenarios: - Staff reiterated advice to eliminate the deficit excluding the Social Security surplus by early in the next decade—an improvement of roughly 4 percent of GDP relative to the staff’s baseline. - Rationale for an early and substantial fiscal effort: - Cyclical considerations: reducing the fiscal deficit by roughly 1 percent of GDP per annum over the next few years would reduce the burden on monetary policy without unduly dragging on short-term activity (alternative scenario in Appendix IV). - Low national saving and large external deficit: a 4 percent of GDP permanent increase in the fiscal balance raises national saving by some 3 percent of GDP over the next 5 years while reducing the external deficit by almost 2 percent of GDP (Appendix IV). - Global policy coordination: decisive U.S. fiscal consolidation would demonstrate leadership under the G-7 Agenda for Growth and could catalyze bolder action by other countries. - Long-term fiscal sustainability: consolidation is essential to place government debt on a clear downward path, improve intergenerational fairness, and allow time to develop and phase in reforms for health and retirement programs. *Prepared from IMF staff report text.* ### 28. Officials agreed that raising national saving was an important policy priority, but ### _cr05257 - 28. Officials agreed that raising national saving was an important policy priority, but ### Fiscal stance, short-term objectives, and revenue - Officials agreed raising national saving was an important policy priority, but saw no need to strengthen their fiscal objective. - The Administration had made substantial progress in putting in place a framework for identifying expenditure priorities and improving spending efficiency that would yield savings in the coming years. - Officials emphasized that revenue enhancements could spur higher spending, and the key to fiscal sustainability was the reform of entitlement programs, rather than achieving a more ambitious near-term deficit target. - Officials viewed a fiscal deficit below 2 percent of GDP—which they were confident of reaching—as appropriate since it was well within the range of historical budget deficits and fiscal positions in other industrial countries. - The mission suggested fiscal sustainability would likely require revenue measures; the President’s Advisory Panel on Federal Tax Reform was charged with reporting on ways to simplify and improve the efficiency of the tax system in a revenue-neutral manner (baseline that included AMT revenues). - The mission argued that the magnitude of the fiscal adjustment needed and already ambitious plans for spending discipline suggested options for revenue enhancements should be actively considered; officials responded that some additional revenues could be expected from higher growth due to greater economic efficiency. - There was broad agreement that a legislated fiscal rule could support consolidation efforts; the Administration sought to re-authorize discretionary spending caps and pay-as-you-go (PAYGO) provisions. - The Administration preferred that PAYGO provisions apply only to expenditure, viewing revenue offsets as a potential encouragement to tax-financed spending increases. ### Long-Term Fiscal Sustainability and entitlement pressures - Authorities agreed long-term unfunded obligations, particularly for health care, posed the largest challenge to U.S. long-term fiscal sustainability. - The actuarial liability of the Social Security system over the next 75 years was estimated at 30 percent of GDP. - The estimated unfunded liability of the Medicare system was 200 percent of GDP, a third of which arose from the prescription drug benefit enacted in 2003. - Medicare and Medicaid together finance half of all U.S. health care outlays, and mission questioned whether Medicare and Medicaid spending could be contained without reforms in the overall health sector. - The United States spends almost twice as much on health care as a ratio to GDP than other OECD countries—a gap only partly explained by income elasticities and consumer preferences. - Actuarial calculations assume per-beneficiary spending grows at 1 percentage point a year above the growth rate of per-capita GDP, while the excess over the last decade has been more like 2–2½ percent, a value that would approximately double the unfunded liability over 75 years. ### Medicare and Medicaid (Box 4) — structure, magnitudes, and FY 2006 proposals - Medicare outlays total some 2½ percent of GDP, comprising: - Hospital insurance (HI). Funded by a 2.9 percent payroll tax; currently running a small surplus (¼ percent of GDP), with assets held in a trust fund; HI deficits are projected from 2018, and the trust fund will be exhausted by 2030. - Supplemental Medical Insurance (SMI). About one-quarter of costs are funded by premiums, with the balance coming from general government revenues. - Prescription drug coverage. Legislated in 2003; benefits become available on January 1, 2006. Only about 25 percent of program costs will be covered by premiums and the cost of standard basic coverage is estimated at $593 billion over the 2004-2013 period by the Congressional Budget Office (CBO). - Medicaid is a joint state-federal program; the federal government pays 50 to 77 percent of state Medicaid expenses (matching rates vary according to state income per capita); total Medicaid outlays comprise over 2½ percent of GDP. - FY 2006 Budget proposals would further shift fiscal responsibility for Medicaid to the states, reducing federal financing by about $45 billion over ten years; the existing cost-sharing arrangement would be replaced by block grants to states indexed to CPI inflation rather than increases in the states’ outlays; financing vehicles would be streamlined and payments to state and local hospitals and nursing homes would be capped. ### Health-sector reform avenues and administration initiatives - Mission questioned whether Medicare and Medicaid spending could be contained without broader health sector reforms, citing inefficiencies and weak incentive structures in the private health insurance system and a large uninsured population. - Officials noted steps taken to strengthen the health care system: - The 2003 Medicare Modernization Act (MMA) introduced tax-preferred Health Savings Accounts to increase consumer cost-sensitivity via high deductible plans. - MMA required pilot projects starting in 2010 to test whether competition between private and traditional fee-for-service plans could improve delivery and reduce costs. - Administration promoted tax preferences for purchases of health insurance by low-income workers and tort reform to curb defensive medicine. - Several years would be needed to gauge success of these initiatives; thereafter a broader national debate on health care reform could be needed. ### Social Security reform proposals and Personal Retirement Accounts (PRAs) - The President endorsed “progressive indexing,” linking future increases in initial benefits to a sliding combination of wage and price indexes; officials stated this would eliminate some 70 percent of the system’s unfunded liabilities while preserving replacement ratios for low-income workers. - Progressive indexing, if coupled with other reforms—such as increasing the statutory retirement age—would close the system’s 75-year actuarial gap and yield a positive cash flow at the end of the 75-year period; the Administration viewed achieving a positive cash flow at the end of the 75-year period as a critical criterion for judging sustainability. - PRAs would permit younger workers to shift up to 4 percentage points of social security contributions into PRAs, coupled with an equivalent reduction (in net present value terms) in future Social Security benefits. - The proposal would cause a significant increase in federal deficits and debt over several decades as implicit liabilities are recognized and transitional costs borne, even though its direct impact on national saving and financial markets would likely be marginal. - The team cautioned PRAs should be coupled with measures to ensure long-term solvency of Social Security and not be introduced without measures to eliminate the system’s unfunded liabilities. ### International context and experience with partial privatization (Box 5) - Progressive indexation could eliminate some three-quarters of Social Security’s 75-year funding gap (source text uses both “some 70 percent” and “some three-quarters” in related passages). - PRAs: individuals could direct up to 4 percentage points of Social Security payroll contributions into PRAs, with traditional benefits scaled back using a 3 percent offset rate; PRA payments would be phased in gradually; individuals would not be able to borrow against PRAs; strict guidelines would include limited investment options and obligatory annuitization at retirement. - Several industrial countries (Australia, Canada, Sweden, United Kingdom) have adopted multi-tier pension systems combining a public minimum safety net with professionally managed accounts; experiences show reduced long-term unfunded liabilities but concerns about adequacy of private savings, low opt-in rates, insufficient investment expertise, and high management costs in some systems. ### Tax reform, national saving, and structural fiscal-policy advice - The mission cautioned it would be important to raise national saving to support capital accumulation and buttress labor productivity; stronger investment would help support the economy’s underlying growth momentum as total factor productivity (TFP) growth likely moderates and the working-age population slows. - Officials emphasized raising the personal saving rate was a core objective of Administration tax-reform plans: tax rates had been lowered significantly on dividends and capital gains, and the Administration supported the complete elimination of the double taxation of the returns to saving. - FY 2006 budget included proposals to consolidate, simplify, and extend existing tax-preferred saving schemes; efforts to strengthen individual incentives for saving, bolster regulations governing corporate pension plans, and place the public pension system on a sustainable footing were being pursued. - The mission cautioned fiscal incentives would be most effective in raising national saving if fully financed; reducing the double taxation of capital income would not necessarily raise national saving and investment unless fiscal revenue losses were offset. - The mission welcomed efforts to promote automatic enrollment and default investment options in private pension plans. - Staff and officials concurred there was considerable scope for reducing complexity and inefficiencies in the tax system: - U.S. tax system has higher statutory tax rates and lower revenue yields than the OECD average, reflecting widespread personal and corporate income tax preferences. - These preferences account for about 40 percent of potential tax revenue, and include significant preferences for employer-provided medical insurance, pension contributions, and charitable giving. - Tax benefits for housing—including mortgage interest deductibility, the treatment of property taxation, and capital gains—were the most generous in the G-7 and helped explain the relatively high ratio of U.S. residential to business investment. - Officials expected the President’s Tax Advisory Panel to recommend base broadening to offset the costs of eliminating the AMT; the panel’s report was due in September and would likely need to recommend cutbacks in major tax expenditures, while taking into account “the importance of homeownership and charity in American society.” - The mission questioned whether a federal VAT or sales tax would be considered; staff noted this could improve efficiency by shifting the burden from income to consumption and could help intergenerational equity given aging population. - Staff also raised the possibility of increased energy taxation to contribute to energy self-sufficiency and generate additional revenues; officials observed energy taxation was not covered by the mandate of the President’s Tax Advisory Panel. *Source: _cr05257 - 28. Officials agreed that raising national saving was an important policy priority, but* ### 42. The U.S. financial sector remains resilient and well regulated. At the time of the ### _cr05257 - 42. The U.S. financial sector remains resilient and well regulated. At the time of the ### Financial sector resilience and risks - The U.S. financial sector "remains resilient and well regulated." - Supervisory officials noted an increase in interest rate spreads, "particularly on high yield instruments, from surprisingly low earlier levels." - Consumer business was a major source of bank revenues, with "strong gains from home-equity loans and mortgage servicing offsetting slower growth of credit card loans and mortgage originations." - Risks from a housing-market correction were judged "relatively low" on a national level, despite regional froth and increased use of riskier mortgage products such as interest-only and adjustable rate loans. - Loan portfolios were described as "well diversified geographically." - Supervisory agencies were close to finalizing guidance (subsequently issued in May) requiring banks to strengthen risk management regarding riskier mortgage products. ### Supervision, regulation, and sectoral reforms - Basel II - Officials noted the timetable for implementing the Basle II framework "could be missed," because time was needed "to analyze the surprisingly large effects on capital ratios coming from the latest round of bank self-assessments." - Corporate governance - Officials suggested reform under Sarbanes-Oxley "had progressed smoothly," and concerns over compliance costs were expected to diminish as the transition completed. - Government-sponsored housing enterprises (GSEs) - The mission supported the Administration’s plans for: establishing an independent regulator; limits on the size of GSE portfolios; allowing the regulator to set capital requirements, design stress tests, and place a financially-weak GSE into receivership. - Congress subsequently took up the issue, but "draft legislation has not included adequate measures to limit the size of GSE portfolios." - Corporate pension reform - The mission welcomed Administration proposals for "strengthening funding incentives and raising disclosure requirements" given "large unfunded liabilities in defined benefit pension plans" and potential costs to the Pension Benefit Guaranty Corporation (PBGC). - Insurance supervision - Following discovery of irregularities in the insurance sector, the mission inquired about a national approach to regulating systemically important insurance companies; officials responded that "state supervision appeared to be adequate" and federal-state supervisory relationships were "strong and effective." - Mortgage lending standards - Recent regulatory moves to tighten lending standards on mortgage instruments were described as "appropriate," given signs that home prices may be exceeding equilibrium levels in some parts of the country. ### Trade policy, Doha Round, and protectionism - Doha Round - Authorities welcomed progress but cautioned "key issues remained unresolved." - Fresh momentum followed resolution over conversion of specific into ad valorem tariffs. - Priorities: secure "sharp reductions in agricultural tariffs among the large industrial and developing countries," minimize sheltered product lists, and achieve progress on non-agricultural market access and services. - Outstanding issues needed to be largely settled before the WTO ministerial meeting in Hong Kong for a 2006 conclusion. - WTO services negotiations - Officials hoped for "higher-quality offers," particularly from developing countries. - Administration explored streamlining the request-offer process, including "benchmark offers of varying ambition." - U.S. flexibility on liberalizing services requiring temporary movement of natural persons "was severely constrained by immigration and security concerns." - U.S. free trade agreements (FTAs) - Authorities reiterated FTAs were "an effective means for promoting multilateral trade liberalization" and "comprehensive in scope." - The mission stressed ensuring this approach "did not undermine the fabric of the multilateral trading system" based on non-discrimination. - Protectionist sentiment - Staff expressed concerns over rising protectionist sentiment in the U.S. Congress. - Officials cautioned it would be difficult to contain without changes in Chinese exchange rate policy. - In response to surging textile imports after quotas expired end-2004, the United States introduced safeguard measures on seven textile products in May; officials emphasized these measures were "compatible with the protocol for China’s WTO accession." - The mission noted that Chinese imports appeared to have displaced primarily suppliers from other foreign countries. ### Official development assistance and external assistance - ODA/GNI ratio - The ODA/GNI ratio "had jumped to 0.16 percent in 2004, up from 0.11 in 2001." - Partly reflected spending on Iraq and Afghanistan; underlying funding had increased. - Authorities noted that U.S. assistance was "several times higher" once private donations and outlays such as defense were taken into account. - Millennium Challenge Account and USAID - The Administration remained committed to maintaining assistance provided by USAID as the Millennium Challenge Account became operational. ### Staff appraisal: macroeconomic outlook and policy priorities - Growth and inflation - "The United States has continued to be the main locomotive of global growth, and nearer term prospects appear broadly favorable." - There have been signs that the pace of expansion "has eased somewhat," and concerns about the record-low household saving rate remain. - Growth was expected to "remain slightly above trend" as "inflation pressures appear to have been contained despite the rise in world oil prices." - U.S. growth was expected to "outperform the rest of the G-7 in 2005." - External imbalances and fiscal risks - The United States’ "heavy reliance on foreign saving and the still-large fiscal deficit" have contributed to global current account imbalances and systemic risk concerns. - Critical priority: "ambitious fiscal consolidation coupled with measures to ensure the long-term sustainability of public health and retirement systems," alongside structural reforms and greater exchange rate flexibility abroad. - Monetary policy - "The Federal Reserve’s gradual and flexible approach to monetary tightening has been been effective." - Interest rate hikes paired with clear communication helped "anchor inflation expectations and allowed a gradual pace of tightening." - Nonetheless, "monetary conditions still appear accomodative" and "a more aggressive pace of interest rate hikes cannot be ruled out," given low unemployment, a recent rise in unit labor costs, and house price inflation. - Inflation objective and transparency - The Federal Open Market Committee debated merits of a "more explicit inflation objective." - The Fed was already "among the most transparent central banks in the world," but a clearer inflation objective could help "anchor inflation expectations and long-term bond yields" without unduly constraining short-term stabilization objectives. ### Fiscal policy, entitlements, and reform recommendations - Deficit reduction - The Administration’s call for deficit reduction was "welcome," but "more ambitious efforts appear warranted," particularly due to looming demographic pressures. - Revenues had strengthened and "may again contribute to a better-than-expected fiscal outcomes this year." - Budget targets for next year and beyond would yield "relatively modest adjustments in the government’s structural position," and achieving these gains may be difficult given expected reliance on "an unprecedented compression in nondefense discretionary spending." - It would be worrying if the fiscal deficit and debt remained high "until the end of the decade" as entitlement pressures from the baby boom generation intensify. - Recommendation: use the current favorable growth conjuncture as "room for bolder deficit reduction over the coming years." - Objective cited: "Achieving a balanced budget excluding Social Security early in the next decade" to support national saving, domestic investment, and the external position. - Revenue and tax reform - Expenditure discipline is essential, but "tax reform should also play a role in supporting fiscal sustainability." - Given the magnitude of fiscal adjustment needed, it is prudent to explore options for revenue enhancements to avoid unwinding recent tax rate cuts. - Options mentioned: "broadening the income tax base—by curbing deductions, such as the generous treatment of mortgage interest—or to taxing consumption more directly in the form of a national consumption or energy tax." - A legislated budget rule and re-authorization of the Budget Enforcement Act (BEA) provisions—including pay-as-you-go provisions that cover revenue measures—were recommended. - Health care and Medicare/Medicaid - "Medicare outlays are on an unsustainable path." - Administration proposals and provisions of the 2003 Medicare Modernization Act "could help moderate price pressures," but with Medicaid strains, a large uninsured population, an aging population, and a "projected tripling of public health care outlays as a ratio to GDP in coming decades," further steps are urgently needed to improve health care efficiency. - A broader reform effort may be required given similar pressures in the private sector. - Social Security and retirement reform - Encouraging steps had been taken to address Social Security solvency. - The Administration supported one proposal "for slowing the growth of benefits." - "Relatively modest additional measures would be required to eliminate the system’s underfunding and to ensure a positive cash flow over the foreseeable future." - The Administration’s proposal for personal retirement accounts (PRAs) "would not help place the system on a sustainable basis and would significantly raise federal deficits and debt in coming decades"; PRAs would need to be combined with a comprehensive plan to ensure long-run solvency. - Key priority: "avoid delays in reforms that fully fund the system," since delays would increase eventual adjustment needs. - Encouraging saving and private risk management - Structural reforms to support saving and capital accumulation would help sustain high labor productivity growth. - The decline in defined-benefit pension and employer-sponsored health care coverage has increased financial risks borne by households. - Public policies should encourage appropriate saving decisions, "including by promoting retirement plans in which participation is the default option." ### Governance of IMF relations and statistics (selected figures and procedural items) - Recommendation: "the next Article IV consultation take place within the standard 12-month cycle." - Fund relations (As of May 31, 2005) - Quota: 37,149.30 (SDR Million) - Quota percent: 100.0 - Fund holdings of currency: 26,702.13 - Fund holdings percent: 71.9 - Reserve position in Fund: 10,445.32 - Reserve position percent: 28.1 - SDR Department - Net cumulative allocation: 4,899.53 (SDR Million) — 100.0 percent - Holdings: 7,718.72 — 157.5 percent - Exchange rate arrangements: "U.S. dollar floats independently and is determined freely in the foreign exchange market." - Payments restrictions: The United States notified the Fund under Decision No. 144 of restrictions on payments and transfers for current international transactions to Libya, Iraq, North Korea, Cuba, and Iran; additional restrictions and notifications are noted in the text. - Statistical dissemination and surveillance - The United States subscribes to the Special Data Dissemination Standard (SDDS). - A table of common indicators required for surveillance is provided (as of June 10, 2005), with frequencies indicated (Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A)). *Source: IMF staff report text provided in content unit _cr05257.* ### 1. This appendix subjects projections for U.S. public debt and external debt to a series ### 1. This appendix subjects projections for U.S. public debt and external debt to a series ### Methodology - Baseline trajectories for public and external debt are determined by setting key macroeconomic variables, including the primary fiscal deficit and the non-interest current account, at values projected by staff following the methodology prescribed in “Assessing Sustainability,” (www.imf.org, May 28, 2002). - The fiscal and external baselines are subjected to two-standard deviation shocks in: - domestic interest rates, - real growth, - inflation, - real exchange rates, - primary fiscal deficit (government debt only), - non-interest current account (external debt only). - Each shock lasts two years, except a flow-of-liabilities shock described as lasting one year. - Net general government debt is defined as the net financial liabilities of federal, state, and local government debt to the public (excluding government debt held by the social insurance trust funds). - Gross external liabilities are used as the measure of the stock of external financing. - Alternative stress tests use vector autoregressions (VAR) to estimate impacts of growth, inflation, and interest shocks on government net debt and to construct a 95 percent confidence interval from macroeconomic shocks included in the VAR (growth, inflation, short- and long-term interest rates, general government fiscal balance, and real effective exchange rates). ### Key findings — Public debt - In all but one case, shocks to the fiscal baseline initially boost public debt, but then debt resumes the downward trend of the baseline scenario (see Table 1a and figure 1a). - Shocks lasting two years in interest rate, primary balance, real exchange rate, and a flow-of-liabilities shock lasting one year show no persistence in the net government debt-to-GDP ratio after the first two years. - Only a shock to real growth presents a persistence problem that may require alternative policy actions. - VAR analysis: a persistent one standard deviation increase in short term interest rates initially accelerates debt accumulation faster than similarly calibrated higher inflation or lower growth, but then stabilizes with debt at 69 percentage points of GDP. - Persistent shocks to growth and inflation (from the VAR) imply continuing increases in government debt over the medium term (figure 1b). - The VAR-based 95 percent confidence interval experiment suggests that more temporary shocks imply relatively limited risks to the government debt path, with uncertainty of around +/- 5 percentage points of GDP after 5 years. ### Key findings — External debt - U.S. external debt appears resilient to shocks in real growth and domestic prices (see Table 1b and figure 2a). - Shocks in the first two years raise the external debt ratio, but it then resumes the trend of the baseline forecast. - The interest rate shock initially raises the level of external debt, but following the shock, external debt levels then rise slower than in all other scenarios including the baseline. ### Implications and scenarios - Temporary (two-year) shocks to interest rates, primary balance, real exchange rates, and a one-year flow-of-liabilities shock are generally absorbed with limited persistence in net general government debt-to-GDP, except when real growth is shocked. - Persistent shocks to growth and inflation represent the more significant threat to domestic debt sustainability, per VAR results. - Uncertainty from the universe of macroeconomic shocks produces an estimated confidence band of approximately +/- 5 percentage points of GDP around the government debt path after 5 years. *Source: APPENDIX III (excerpts).* ### 6. The external sector VAR finds that persistent real effective exchange rate shocks ### 6. The external sector VAR finds that persistent real effective exchange rate shocks ### VAR results on external shocks and debt dynamics - Staff used the net international investment position (IIP) to better control for the outflow of investment funds by U.S. nationals relative to the financing needs of the current account. - The VAR finds that persistent real effective exchange rate (REER) shocks could marginally worsen the U.S. debt position, while higher inflation or lower growth may actually improve the debt profile. - Given susceptibility of net IIP to interest rate, growth, inflation, and real exchange rate shocks, the VAR estimates a 95% confidence interval of +/- 6 percentage points of GDP in the fifth year of the staff forecast. ### Sensitivity analysis and static stress-test findings - Static stress tests indicate general government net debt ratio is most susceptible to a sudden increase in debt flows. - Vector autoregression sensitivity displays impacts on general government net debt (percent of GDP) under: - Staff baseline forecast - 1 s.d. inflation shock - 1 s.d. short term interest rate shock - 1 s.d. real GDP growth shock - Net International Investment Position (percent of GDP) series shown with: - Staff baseline forecast - 95% confidence interval of baseline - 1 s.d. REER depreciation - 1 s.d. real GDP shock - 1 s.d. inflation shock ### Debt sustainability projections and identified debt-creating flows (selected figures) - Public sector debt (percent of GDP) projections, selected years: - 2000: 57.1 - 2001: 56.6 - 2002: 58.6 - 2003: 60.5 - 2004: 61.0 - 2005: 61.9 - 2006: 62.7 - 2007: 62.9 - 2008: 62.9 - 2009: 62.6 - 2010: 62.3 - Change in public sector debt (selected sequence): -5.6, -0.6, 2.0, 1.9, 0.5, 0.9, 0.9, 0.1, -0.1, -0.2, -0.3 - Identified debt-creating flows (4+7+12): -4.8, -1.1, 2.0, 1.9, 0.5, 0.9, 0.9, 0.1, -0.1, -0.2, -0.3 - Primary deficit (percent of GDP): -5.0, -2.7, 0.9, 1.9, 1.5, 1.5, 1.0, 0.1, -0.4, -0.7, -1.0 - Automatic debt dynamics (contribution, percent of GDP): 0.2, 1.6, 1.1, 0.0, -1.0, -0.6, -0.2, 0.0, 0.3, 0.5, 0.7 - Contribution from real interest rate (percent): 2.4, 2.1, 2.1, 1.7, 1.5, 1.5, 1.9, 2.2, 2.4, 2.5, 2.7 - Contribution from real GDP growth (percent): -2.2, -0.4, -1.0, -1.7, -2.5, -2.1, -2.1, -2.2, -2.1, -2.0, -2.0 - Residual, including asset changes (2-3): -0.8, 0.5, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0 - Public sector debt-to-revenue ratio (percent): 179.4, 184.0, 208.0, 218.6, 218.7, 219.2, 221.7, 220.5, 219.5, 218.3, 211.8 ### External debt sustainability (selected figures) - External debt (percent of GDP): 2004: 101.8; 2005: 107.9; 2006: 114.0; 2007: 120.0; 2008: 126.0; 2009: 131.9; 2010: 137.7 - Change in external debt (percent of GDP): 0.5, -0.6, -3.5, 8.1, 6.3, 6.1, 6.1, 6.0, 5.9, 5.9, 5.8 - Identified external debt-creating flows (4+8+9, percent of GDP): -6.1, -1.8, 0.2, 0.0, -2.1, -1.3, -1.6, -1.9, -2.2, -2.4, -2.8 - Current account deficit, excluding interest payments (percent of GDP): 7.5, 6.3, 6.9, 7.1, 8.5, 8.8, 9.6, 10.1, 10.5, 10.5, 10.7 - Automatic debt dynamics (contribution, percent of GDP): -8.4, -5.3, -5.5, -6.4, -8.8, -8.8, -9.7, -10.6, -11.2, -11.4, -11.9 - Contribution from nominal interest rate: -3.3, -2.5, -2.4, -2.3, -2.9, -3.0, -3.9, -4.4, -4.8, -5.0, -5.2 - Contribution from real GDP growth: -3.1, -0.7, -1.6, -2.5, -4.0, -3.5, -3.7, -3.9, -4.0, -4.0, -4.2 - Contribution from price and exchange rate changes: -1.9, -2.1, -1.5, -1.6, -2.0, -2.3, -2.2, -2.2, -2.4, -2.5, -2.6 - External debt-to-exports ratio (percent, selected): 2000: 83.8; 2001: 91.4; 2002: 93.9; 2003: 103.0; 2004: 104.1; 2005: 105.3; 2006: 106.9; 2007: 109.4; 2008: 112.3; 2009: 114.7; 2010: 116.9 ### Alternative scenarios and bound tests (selected outcomes) - A3. Country-specific shock in 2005, with reduction in GDP growth (relative to baseline) of one standard deviation yields public sector debt series: 61.9, 62.7, 62.9, 62.9, 62.6, 62.3, 0.7 (table entries preserved as in source). - B5. One time 30 percent real depreciation in 2005 leaves public sector debt at: 61.9, 62.7, 62.9, 62.9, 62.6, 62.3, 0.7. - External-bound tests (B1–B6) present alternative external debt trajectories under shocks to interest rates, growth, dollar deflator, and one-time nominal depreciation; selected outcomes include external debt percent of GDP rising to as high as 143.4 under B2 and 141.6 under B5 combination scenarios. ### Impact of Fund policy advice (Global Fiscal Model simulation) - Policy simulated: permanent 4 percent of GDP improvement in the fiscal deficit, building over 5 years. - Implementation assumption: labor taxes are raised so as to strengthen the fiscal balance by a percentage point of GDP a year between 2006 and 2009. - Adjustment for nominal rigidities: responses in 2006 were reduced by two-thirds and in 2007 by one-third, except for the impact on the budget deficit. - Monetary policy assumption: monetary policy is assumed to aim at stabilizing activity and prices. - Real activity impact (percent change from policy baseline): - Real GDP: 2006 -0.3; 2007 -0.6; 2008 -0.9; 2009 -0.9; 2010 -0.7 - Fiscal and external outcomes (percent change or cumulative impact from policy baseline): - Federal budget balance (levels as a ratio to GDP): 2006 1.0; 2007 2.0; 2008 3.0; 2009 4.0; 2010 4.0 - Federal debt (cumulative impact, as a ratio of GDP): 2006 -1.0; 2007 -3.0; 2008 -5.8; 2009 -9.5; 2010 -13.2 - Current account (levels as a ratio to GDP): 2006 0.5; 2007 1.0; 2008 1.7; 2009 1.9; 2010 2.0 - Net foreign assets (cumulative impact, as a ratio of GDP): 2006 0.5; 2007 1.5; 2008 3.1; 2009 4.9; 2010 6.7 - Real exchange rate (percent change): 2006 -1.9; 2007 -3.6; 2008 -5.4; 2009 -5.3; 2010 -5.1 - Net results by 2010: - Government debt is some 13 percentage points below its baseline value. - Net foreign assets are some 7 percentage points of GDP higher. ### Key macroeconomic context (selected indicators supplied) - Real GDP growth (historical and projected averages, percent): 3.7 (average), 0.8 (deviation), 1.9, 3.0, 4.4, 3.3, 1.3, 3.6, 3.6, 3.6, 3.5, 3.4, 3.3, 3.3, 3.5 - Inflation rate (GDP deflator, percent): 2.2, 2.4, 1.7, 1.8, 2.1, 1.8, 0.4, 2.3, 2.0, 2.0, 2.0, 2.0, 2.0, 2.0, 2.1 - Average nominal interest rate on public debt (percent): 6.2, 6.1, 5.5, 4.9, 4.8, 6.1, 0.7, 5.0, 5.4, 5.8, 6.0, 6.3, 6.5, 5.9 *Source: _cr05257 - 6. The external sector VAR finds that persistent real effective exchange rate shocks* ### 1. This note reports on information that has become available since the staff report ### _cr05257 - 1. This note reports on information that has become available since the staff report ### Recent economic and financial market developments - Labor market and activity: - June payroll employment rose by 146,000 (1¼ percent on an annualized basis). - Unemployment rate fell 0.1 percentage points to 5 percent. - Industrial production increased by 0.9 percent (month-on-month). - Retail sales increased by 1.7 percent (month-on-month). - Trade deficit fell to $55.3 billion in May from $56.9 billion in April. - Relatively strong export growth and a temporary dip in oil prices contributed to the lower trade deficit. - Consumer and producer sentiment have improved. - Inflation and bond markets: - June 12-month increase in overall consumer prices moderated to 2.5 percent. - June 12-month core consumer prices moderated to 2.1 percent. - Headline producer price inflation fell to 3.6 percent. - Core producer price inflation fell to 2.2 percent. - Spreads between conventional and inflation-indexed 10-year bonds declined slightly to around 2¼ percent. - Financial market responses: - Long-term bond yields increased by about ¼ percentage point to around 4¼ percent. - Market expectations for the Federal Reserve: a further 75 basis points of tightening expected by end-2005. - Stock prices have strengthened somewhat. - After early July appreciation, the dollar returned to its June level. ### Monetary, fiscal and legislative developments - Federal Reserve and macro outlook: - The Federal Reserve’s Monetary Policy Report projects core PCE inflation will remain below 2 percent and economic growth will be sustained at around 3½ percent this year and next, assuming no further oil price spikes. - Chairman Greenspan indicated further monetary tightening would likely be necessary as economic slack diminishes. - Budget outlook and projections: - Administration’s Mid-Session Review lowered the projected unified deficit for FY 2005 to $333 billion (2¾ percent of GDP), compared with the February estimate of $412 billion (3½ percent of GDP). - Stronger revenues reduced anticipated deficits by around ½ percent of GDP in subsequent years. - Unified federal deficit projected to remain at 2¾ percent of GDP in FY 2006 and to fall to almost 1 percent of GDP by FY 2010, including some costs in FY 2009 and FY 2010 from assumed introduction of Personal Retirement Accounts (PRAs). - Legislative developments: - No consensus in Congress on Social Security reform or on introducing PRAs; debate postponed until after the August recess. - Reconciliation of energy bills passed by the two chambers is underway. - A corporate pension reform bill to tighten defined-benefit pension funding requirements is on track for a House vote. - The Central America Free Trade Agreement has passed the Senate but has yet to be voted on in the House. - United States unified budget (percent of fiscal year GDP) — FY 2004 through FY 2010 (selected items reproduced exactly as in source): - FY 2006 Mid-Session Review: - Outlays 19.8 20.1 20.2 19.5 19.1 19.0 19.1 - Net interest expense 1.4 1.5 1.6 1.7 1.7 1.7 1.8 - Revenue 16.3 17.4 17.5 17.7 17.9 17.9 18.1 - Unified balance -3.6 -2.7 -2.6 -1.7 -1.1 -1.1 -1.1 - FY 2006 Budget: - Outlays 19.8 20.3 19.9 19.5 19.2 19.1 19.0 - Net interest expense 1.4 1.5 1.6 1.8 1.9 1.9 2.0 - Revenue 16.3 16.8 16.9 17.2 17.5 17.5 17.7 - Unified balance -3.6 -3.5 -3.0 -2.3 -1.7 -1.5 -1.3 - Difference (Mid-Session Review minus FY 2006 Budget): - Outlays -0.1 0.3 -0.1 -0.2 -0.1 0.1 - Net interest expense 0.0 -0.1 -0.1 -0.2 -0.2 -0.2 - Revenue 0.6 0.7 0.5 0.5 0.4 0.3 - Unified balance 0.8 0.4 0.6 0.6 0.5 0.2 - Note: Includes allowance for costs of operations in Iraq and Afghanistan in FY 2006 as well as PRA expenses of $25b in FY 2009 and $50b in FY 2010. ### Public Information Notice and Executive Board Assessment (IMF Article IV, July 22, 2005) - Background and near-term outlook: - The U.S. economy led the global recovery; after expanding at a 4½ percent rate in 2004, real GDP growth eased to 3¾ percent in Q1 2005. - Staff projects growth of 3½ percent in 2005 and 2006. - Some further softening may have occurred in Q2 2005, but indicators suggest activity will regain momentum in the second half of 2005. - Domestic demand remains solid, supported by steady employment gains, business investment, and improving consumer confidence. - Inflation, productivity, and labor market: - Core PCE has risen to just above 1½ percent (12-month rate). - Headline CPI inflation around 2½ percent in recent months due to higher energy prices. - Slower productivity growth since mid-2004 contributed to an acceleration in unit labor costs. - Employment growth moderate by historical standards; drop in unemployment rate to 5 percent largely reflected lower participation. - External imbalances and financial flows: - Current account deficit rose to a record 6½ percent of GDP in Q1 2005 (assuming unchanged real exchange rate in staff projections, the deficit would remain at over 6 percent of GDP). - U.S. net international liabilities estimated to have risen to over 20 percent of GDP. - Net lending by the corporate sector at record highs. - Federal government budget shifted from a 2½ percent of GDP surplus in FY 2000 to a 3½ percent of GDP deficit in FY 2004; general government deficit at 4¼ percent of GDP in calendar year 2004. - Household saving rate has fallen to record lows; IMF staff estimates saving rate is currently some 1½-2 percentage points below a level consistent with household income and wealth. - Financial sector and housing: - Equity prices have risen; long-term interest rates remain low. - Banks are well capitalized and highly profitable; indicators of credit quality remain strong. - Robust housing market prompted tighter oversight of home equity and other residential loans. - Securitization of mortgage debt has limited systemic financial sector risks by diversifying real estate exposures. - Regulators moved to tighten lending standards on mortgage instruments. - Executive Directors' key views and recommendations: - Near-term outlook broadly favorable but subject to risks, including higher oil prices and rapid house price inflation. - Concern over low U.S. national saving rate and large, persistent external current account deficit; level of the U.S. dollar remains above that necessary to avoid continuing increases in U.S. net external indebtedness. - Importance of a cooperative strategy to address global imbalances. - Fiscal policy: - Welcome commitment to fiscal deficit reduction in the FY2006 budget and improvement in budgetary outlook due to strong tax receipts. - Most Directors considered the Administration’s goal of halving the budget deficit relatively unambitious and urged more ambitious fiscal consolidation using the current cyclical strength. - Many Directors recommended balancing the budget excluding Social Security by early next decade to support national saving and reduce federal debt ratio. - Exploration of revenue enhancements was advised to support deficit reduction without undoing recent tax rate cuts; options included broadening the income tax base or taxing consumption more directly (national consumption or energy tax). - Some Directors suggested a legislated budget rule and re-authorization of the Budget Enforcement Act (BEA) provisions, including pay-as-you-go for revenue measures. - Simplification of the tax system and the Advisory Panel on Federal Tax Reform were welcomed. - Social Security and health care: - Severe underfunding of Social Security and especially Medicare noted; public health care spending projected to triple as a ratio to GDP in coming decades absent reforms. - PRAs welcomed but noted they will not reduce the system’s funding gap; accompanying measures needed to ensure long-run solvency. - Directors called for early legislative action to eliminate funding shortfall. - Monetary policy: - Commended Federal Reserve’s gradual and flexible tightening; a clearer inflation objective was suggested by a few Directors though most saw limited additional gain. - Structural reforms: - Importance of reforms to support saving, capital accumulation, and high labor productivity (e.g., aligning tax burden on saving and consumption; promoting retirement plans with default participation). - Welcomed Administration emphasis on strengthening pension funding, improving supervision, and shrinking GSE balance sheets. - Noted possible need for supervision of systemically important insurance entities at national level after recent irregularities. - Trade and development: - Welcomed Administration proposals for deep cuts in agricultural and non-agricultural tariffs in Doha Round and stronger commitments for liberalization in services. - Cautioned about ensuring bilateral free trade agreements are consistent with multilateral trading system. - Urged resistance to protectionist pressures. - Praised recent increases in U.S. official development assistance (ODA) and progress on the Millennium Challenge Account, while noting U.S. ODA as a proportion of GNI remains one of the lowest among industrial countries and encouraging further increases. ### Selected economic indicators (selected entries from Table 1; annual change in percent unless otherwise noted) - Real GDP growth: - 1998: 4.2 - 1999: 4.4 - 2000: 3.7 - 2001: 0.8 - 2002: 1.9 - 2003: 3.0 - 2004: 4.4 - Unemployment rate (percent): - 1998: 4.5 - 1999: 4.2 - 2000: 4.0 - 2001: 4.8 - 2002: 5.8 - 2003: 6.0 - 2004: 5.5 - CPI inflation: - 1998: 1.5 - 1999: 2.2 - 2000: 3.4 - 2001: 2.8 - 2002: 1.6 - 2003: 2.3 - 2004: 2.7 - Unified federal balance (billions of dollars) and percent of FY GDP: - Unified federal balance (billions): 69 (1998), 126 (1999), 236 (2000), 128 (2001), -158 (2002), -378 (2003), -412 (2004) - In percent of FY GDP: 0.8 (1998), 1.4 (1999), 2.4 (2000), 1.3 (2001), -1.5 (2002), -3.4 (2003), -3.6 (2004) - Current account balance: - In billions of dollars: -214 (1998), -300 (1999), -416 (2000), -389 (2001), -475 (2002), -520 (2003), -668 (2004) - In percent of GDP: -2.4 (1998), -3.2 (1999), -4.2 (2000), -3.8 (2001), -4.5 (2002), -4.7 (2003), -5.7 (2004) - Saving and investment (as a share of GDP): - Gross national saving: 18.3 (1998), 18.1 (1999), 18.0 (2000), 16.4 (2001), 14.2 (2002), 13.5 (2003), 14.0 (2004) - Gross domestic investment: 20.3 (1998), 20.6 (1999), 20.8 (2000), 19.1 (2001), 18.4 (2002), 18.4 (2003), 19.7 (2004) *Source: IMF staff note reporting information available since the staff report and Public Information Notice (PIN) No. 05/100, July 29, 2005.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05257.pdf_