## United States: Selected Economic Indicators ## Source details **Canonical URL:** [United States: Selected Economic Indicators](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12213.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12213.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12213.pdf.json) --- ### Backdrop: Still a Fragile Recovery - Growth and labor - Growth decelerated to around 2 percent in the first half of 2012 after rebounding in the second half of 2011. - Job creation slowed considerably since April 2012 after being surprisingly strong in late 2011 and early 2012. - Employment-to-population ratio remains about 4 percentage points below its level in December 2007. - Over 40 percent of the unemployed have been out of work for over six months. - Household sector and housing - Net worth-to-disposable income ratio for the household sector is now slightly above pre-housing boom levels; majority of households remain well below pre-boom net-worth ratios due to depressed house prices and elevated debt. - House prices increased in February, March, and April 2012; large “shadow” inventory leaves risk of further declines significant. - Foreclosures continue to impose high costs through adverse impacts on house prices and household wealth. - Housing starts have been rising since 2011Q3; starts in 2012Q1 were more than 20 percent higher than a year earlier, but remain at only about one half of their 1990s average. - Staff estimates an excess supply of housing will be absorbed gradually as household formation normalizes. - Business sector and trade - Business fixed investment lost momentum starting in 2011Q4; partial phasing out of accelerated depreciation incentives in January 2012 may have pulled some investment forward into 2011. - Net exports failed to add to growth over the last two quarters; imports rebounded but exports decelerated through 2011 and showed weakness in April and May 2012. - The dollar appreciated 7 percent in real terms between its July 2011 trough and June 2012. - Current account deficit: edged up to 3.1 percent of GDP in 2011 and widened to 3.6 percent of GDP in 2012Q1. - Fiscal and monetary backdrop - U.S. general government deficit was about 9½ percent of GDP in 2011. - Fiscal impulse turned negative in 2011 for the first time since the financial crisis; the GG structural primary deficit fell by ¾ percent of GDP in 2011. - Fiscal policy remained a drag in 2012Q1 while some supportive measures were extended through 2012 (payroll tax cut and emergency unemployment benefits). - Federal Reserve actions: - August 2011: guidance anticipating exceptionally low federal funds rate at least through mid-2013. - January 2012: guidance that low rates likely warranted at least through late 2014. - September 2011: “Operation Twist” — purchases up to $400 billion in Treasury securities with 6–30 year maturities and sales of an equal amount of securities with maturities of 3 years or less (to be completed by June 2012); reinvestment of principal payments on agency debt and MBS into agency MBS. - June 20, 2012: continuation through end-2012 of a program to extend the average maturity of securities holdings (sales/redemptions of about $267 billion in shorter-term securities and purchases of longer-maturity Treasury securities of an equal amount by end-2012); once completed, the Fed will hold almost no securities maturing through January 2016. - Estimated effects of Fed actions: - Estimated reduction in ten-year Treasury yields of some 60 basis points. - Common elasticities imply a 60 basis point decline in the ten-year yield is equivalent to a federal funds rate easing of some 150 basis points, with a growth impact of roughly 0.3 percentage points for each of the next two years. - Inflation and wages - Headline CPI: peaked at 3.8 percent in September 2011; declined to 1.7 percent in May 2012. - Core CPI has hovered around 2 percent. - Wage inflation was 1.4 percent (year-on-year) in May 2012. - Long-term inflation expectations remain stable; the Fed announced a formal 2 percent inflation goal in January 2012. ### Transmission, Credit, and Financial Sector - Mortgage market frictions - Large declines in long-term rates have been less effective in stimulating mortgage refinancing because of high loan-to-value ratios, tighter credit standards, and rigidities in the mortgage market. - Mortgage refinancing volumes and passthrough to disposable income and consumption have been constrained. - Financial conditions - Despite very low long-term rates, obstacles to refinancing have limited the boost to aggregate demand. - The Fed’s securities holdings provide an amount of “effective easing” broadly consistent with historical relationships between the federal funds rate and inflation/unemployment gaps. ### Outlook and Risks (Staff Projections and Assumptions) - Growth projections - Staff projects GDP growth of 2 percent in 2012 and 2.3 percent in 2013. - Key baseline assumptions - House prices expected to bottom out around mid-2012 and increase very slowly thereafter. - Bank credit conditions for households and small businesses expected to ease only slowly. - GG structural primary balance projected to improve by 1 percent of GDP in 2012, subtracting about ½ percentage point from growth. - Baseline for 2013 envisages a relatively modest reduction in the GG structural primary balance of 1¼ percent of GDP. - Automatic spending cuts (the “sequester”) are expected to be replaced by other back-loaded measures in staff’s baseline. - Monetary conditions expected to remain accommodative with policy tightening beginning around late 2014 and a gradual unwinding of the Fed’s securities holdings starting in early 2014. - Private investment in equipment and software expected to expand more slowly than in early recovery but remain a strong contributor to growth. - Residential investment projected to start adding to growth from 2012 onwards after six consecutive years of negative contributions. - Stronger dollar and weaker global demand projected to weigh on exports; net international trade expected to subtract from growth over 2012–2017. - Headline and core inflation projected to remain subdued and reach the Fed’s 2 percent medium-term goal only in the medium term. - Labor market forecast - Unemployment rate projected to decline slowly to 7.9 percent in 2013. - Long-term unemployment will likely remain elevated and may lag aggregate unemployment improvements. ### Major Downside Risks - Overall: risks remain tilted to the downside—external (notably euro area debt crisis) and domestic (notably fiscal cliff and debt ceiling impasse). - External risks: euro area debt crisis and spillovers - Trade channel: euro area accounts for about 15 percent of overall U.S. exports or 2 percent of GDP. - Example scenario: a two percentage point drop in euro area growth accompanied by a 5 percent real effective appreciation of the dollar could reduce U.S. GDP by between ¾ and 1 percentage point over a two-year horizon. - Generalized market contagion: a bout of financial stress similar to July–November 2011 could reduce U.S. real GDP by about 0.6 percentage point over two years. - Pressure on MMMFs: prime MMMFs’ exposure to the core euro area halved over the last year but remains material. - Deleveraging by EU banks: April 2012 GFSR “weak EU policies” scenario projected a reduction of some US$230 billion in U.S. assets held by EU banks; claims by EU banks on the United States fell by $170 billion during 2011Q4. - Stock market valuation channel: U.S. multinationals with substantial sales in the euro area could see profitability and valuations affected. - Domestic risks: fiscal cliff, debt ceiling, medium-term sustainability - Fiscal cliff: if all temporary tax provisions expire and automatic spending cuts take effect, 2013 fiscal contraction would be very sizable (over 4 percent of GDP), reducing annual growth to around zero and contracting the economy in early 2013. - Anticipatory effects: CBO estimates spending held back by policy uncertainty could subtract perhaps ½ percent from (annualized) growth in the second half of 2012. - Debt ceiling: likely to need raising most likely in early 2013, risking heightened uncertainty and market disruption. - Medium-term sustainability: failing to adopt a credible medium-term plan would raise risks, including erosion of reserve currency status and upward pressure on Treasury yields. ### Upside Risks - Pent-up demand could support recovery: - Strong nonfinancial corporate balance sheets could yield stronger-than-expected capital investment if uncertainty falls. - Housing: staff estimate one hundred thousand additional housing starts by end-2013 could lead to an increase in GDP growth of 0.2 percent in 2012 and 2013. - A slower fiscal withdrawal than in the baseline, if embedded in a credible consolidation framework, would help lift growth. ### Policy Discussion: Sustaining Recovery and Reducing Vulnerabilities - Focus areas - Appropriate pace, timing, and composition of fiscal consolidation. - Room and need for further monetary policy easing. - Additional measures to unclog housing markets and reduce risks from persistently high long-term unemployment. - Progress and remaining challenges in financial regulatory reform. - Fiscal consolidation framework - Budget Control Act caps discretionary spending; failure of the Congressional Committee on Deficit Reduction led to scheduled deep automatic spending cuts (“sequester”) starting in 2013. - Overall savings from discretionary caps and sequester: $2.1 trillion over 10 years, but still insufficient to stabilize the debt ratio. - Staff recommendation: replace automatic cuts with specific, back-loaded measures generating equal savings; agree on an ambitious and comprehensive consolidation framework to stabilize the public debt ratio by mid-decade and put it on a downward path. - A medium-term primary surplus of at least 1 percent of GDP would help achieve debt stabilization. - Composition of consolidation - With discretionary spending capped and defense outlays projected to fall, attention must shift to entitlements and revenue increases. - Staff considers medium-term growth assumptions in the administration’s proposals optimistic relative to IMF, CBO, and Consensus projections. ### Revenues and Tax Reform - Personal tax expenditures amount to some 7 percent of GDP and disproportionately benefit high-income households. - Options to raise revenues discussed: - Curb personal tax expenditures within fundamental tax reform. - Introduction of a VAT and carbon taxes. - Higher marginal personal income tax rates. - Improve corporate taxation: broadening the base, lowering marginal rates, and more efficient tax treatment of multinationals. - Pace and composition of fiscal consolidation - Staff recommended a measured pace of deficit reduction given persistent weakness. - President’s FY2013 budget envisages a reduction in the federal deficit by 3 percent of GDP in FY2013 (from 8½ percent to 5½ percent of GDP). - CBO estimate: President’s budget would imply only a 2 percent of GDP adjustment. - Staff suggested targeting a federal deficit of about 6¼ percent of GDP for FY2013—¾ percentage point of GDP higher than planned in the President’s budget proposal—consistent with a reduction in the GG structural primary deficit of around 1 percent of GDP in calendar year 2013. - Deficit reduction should be as growth-friendly as possible, prioritizing infrastructure spending, training programs, housing initiatives, and further extension of emergency unemployment benefits. ### Housing Policy and Measures to Support the Market - Recent measures and outcomes - Expansion of Home Affordable Refinancing Program (HARP) and strengthening of Home Affordable Modification Plan (HAMP). - October 2011 HARP expansion appears to have led to a significant increase in HARP refinancing; share of loans with principal reductions under HAMP has been rising. - State Attorneys General Settlement with major banks could lead to up to $34 billion of principal reduction. - Policy recommendations to accelerate recovery - Support mortgage modifications: encourage GSE participation in principal reduction programs; forceful implementation of HAMP expansion; consider shared appreciation mechanisms. - Support refinancing on a larger scale: ease frictions hindering cross-servicer refinancing; expand program to non-GSE borrowers. - Facilitate conversion of foreclosed properties into rental units: timely expansion of FHFA pilot recommended. - Consider allowing mortgages to be modified in personal bankruptcy courts (“cramdowns”) to align treatment of primary residences with most other secured debt. ### Labor Market Challenges and Policies - Cyclical factors explain most current weakness, but risk exists that structural unemployment may rise. - Long-term unemployment is at 3.5 percent of the labor force and remains elevated. - Policies discussed and recommended - Job Creation Act of February 2012: extension of payroll tax cuts through 2012; requirement that recipients of long-term unemployed benefits take up job search services and training/education services. - Administration proposals (not approved by Congress): American Job Act of 2011; 2013 Budget active labor market policies including Pathways Back to Work and a 10 percent tax credit for new jobs and wage increases. - Staff supported targeted tax incentives for employment creation and more resources for programs helping the long-term unemployed return to work; cautioned against abrupt reduction of extended unemployment benefits. ### Financial Sector: Conditions, Risks, and Reform Progress - Banking system outlook - Earnings growth positive over the last 11 quarters; regional stresses persist in Arizona, California, Florida, Georgia, and Nevada. - Mortgage credit supply remains tight; the Fed’s Senior Loan Officer Opinion Survey shows almost no easing of mortgage standards since the crisis. - Large backlog of troubled mortgages, regulatory uncertainty, and scaled-down real estate lending operations weigh on banks’ willingness/capacity to supply mortgage credit. - Risks from global financial stresses - Concerns about vulnerabilities of largest U.S. banks to euro area stresses given large derivative portfolios and dependence on wholesale funding. - Self-reported data on six largest U.S. banks suggest aggregate net exposure to peripheral Europe was about US$57 billion at end 2011. - Shadow banking and market structure - MMMF asset base: US$2.5 trillion—about one third below its end-2008 peak. - Private-label securitization remains well below pre-crisis levels; issuance of CDOs has evaporated. - Insurance companies and defined-benefit pension funds - Official estimate: corporate pension underfunding was about $700 billion as of 2010. - Progress on financial reform implementation - Achievements: living wills, criteria for non-bank SIFI designation, groundwork for centralized clearing of OTC derivatives, Basel 2.5 follow-up; initial Basel III rulemakings underway. - Timeline/details: - Final rule on Basel III standards expected around timeline agreed with the Basel Committee (January 2013). - Dodd-Frank provision on greater capital buffers for systemically important banks (assets above $50 billion) to be implemented with the G-SIB surcharge between 2016 and 2018. - Liquidity Coverage Ratio implementation will not begin until 2015; Net Funding Stable Ratio implementation will not begin until 2018. - Areas requiring further work - Regulation of MMMFs, tri-party repo reform, finalization of Volcker Rule with careful definitions, insurance regulation coordination, quick completion of risk retention regulation and Qualified Mortgage (QM) rules, and a medium-term strategy for the GSEs. - Systemic oversight and resources - FSOC and OFR steps noted; funding constraints for regulatory agencies are a priority to address. ### External Sector, Global Rebalancing, and Exchange Rate Assessment - Current account and NIIP - U.S. NIIP reached -27 percent of GDP at end-2011. - Cyclically-adjusted current account deficit is 1–2 percentage points of GDP weaker than the value implied by fundamentals and desirable policies. - Real effective exchange rate is moderately overvalued (0–15 percent). - Model-based assessments (Box 8) - Structural current account deficit of 1½–2½ percent of GDP consistent with fundamentals; implies adjustment of 1–2 percent of GDP relative to staff baseline. - Real exchange rate depreciation of about 0‒15 percent consistent with fundamentals. - EBA: current account gap around 2 percent of GDP. - CGER: current account gaps around 1-2 percent of GDP. - Overall model-based misalignment range for real exchange rate: about 0–15 percent. - Global spillovers - Materialization of the fiscal cliff would stall the U.S. economy and transmit negative effects via trade, with strongest impacts on Canada and Mexico. ### Carbon Tax Consideration (Box 4) - U.S. Interagency Working Group recommendation: a carbon tax of about $20 per metric ton of CO2. - Could be raised by about 2–5 percent annually in real terms, cutting emissions by 5–15 percent. - Could raise about $100 billion annually, or 0.6 percent of GDP. - Distributional mitigation: compensate low-income households at a cost of less than 10 percent of carbon tax revenues. ### Annex I: Downside Risk Assessment Matrix — Key Points and Debt Trajectory - Four principal downside threats with assessed likelihoods and impacts: - 1. “Fiscal cliff”: Likelihood of severe realization in next 1–3 years: High; Expected impact if realized: High — fiscal consolidation of over 4 percent of GDP in 2013 would reduce annual growth to around zero. - 2. Lack of medium-term plan for fiscal consolidation: Likelihood: High; Expected impact: High. - 3. Weaker housing market: Likelihood: Medium; Expected impact: Medium — "A 10 percent decline in house prices relative to the baseline would subtract about 0.3 percent from 2013 growth." - 4. Contagion from Euro area debt crisis: Likelihood: Medium; Expected impact: Medium. - Congressional legislation and timing - Congress has legislated about $2.1 trillion in medium-term fiscal consolidation measures. - Budget Control Act (August 2011): capped discretionary spending, saving about $900 bn over 10 years; will trigger automatic appropriations cuts (“sequester”) worth $1.2 trillion over 10 years beginning January 2013 unless modified. - Debt trajectory (staff baseline and selected projections) - Federal debt held by the public projected to increase from about 70 percent of GDP now to around 85 percent of GDP in FY2022. - General government gross debt approaching 120 percent of GDP by CY2021. - Baseline public sector debt (percent of GDP) - 2007: 67.2; 2008: 76.1; 2009: 89.9; 2010: 98.4; 2011: 102.8; 2012: 106.7; 2013: 110.7; 2014: 112.7; 2015: 113.0; 2016: 113.0; 2017: 112.8. - Identified debt-creating flows (percent of GDP, selected) - Primary deficit (includes interest receipts): 2012: 5.4; 2013: 3.9; 2014: 2.1; 2015: 1.0; 2016: 0.7; 2017: 0.3. - Revenue and grants including interest receipts: 2012: 31.5; 2013: 32.9; 2014: 33.8; 2015: 34.6; 2016: 34.9; 2017: 34.7. - Primary (noninterest) expenditure: 2012: 36.9; 2013: 36.8; 2014: 35.9; 2015: 35.6; 2016: 35.6; 2017: 35.1. - Staff recommendation: aim for a medium-term primary surplus of at least 1 percent of GDP to put the public debt ratio on a downward path and build a margin for higher interest costs. ### Recent Developments, Executive Board Assessment, and Key Statistics - Recent macro data and outlook - Annualized real GDP growth estimated at 1.5 percent for the second quarter (below staff projection of 1.7 percent). - National accounts revisions released on July 27th indicate growth was lower in 2010 and higher in 2011 than previously thought. - Financial stability and regulatory updates - On July 18, 2012, FSOC designated eight financial market utilities as systemically important. - FSOC published its second annual report on July 18, 2012; the U.S. Treasury’s OFR issued its inaugural annual report on July 20th. - Executive Directors’ assessments and recommendations - Use limited policy space to support near-term recovery and restore medium-term fiscal sustainability. - Remove uncertainty from the fiscal cliff and promptly raise the debt ceiling. - Monetary policy should remain highly accommodative; room for further easing if outlook deteriorates. - Urged timely and aggressive implementation of housing support measures and funding for active labor market policies. - Commended progress on financial reforms and stressed need to strengthen regulation of MMMFs, finalize the Volcker Rule, accelerate Basel III adoption, wind down GSEs’ role, and ensure adequate regulatory resources. - Key statistics (annual change in percent, unless otherwise indicated) - Real GDP: 2007 1.9; 2008 -0.3; 2009 -3.5; 2010 3.0; 2011 1.7; 2012 2.0 (projection); 2013 2.3 (projection). - Unemployment rate: 2007 4.6; 2008 5.8; 2009 9.3; 2010 9.6; 2011 9.0; 2012 8.2; 2013 7.9. - CPI inflation: 2007 2.9; 2008 3.8; 2009 -0.3; 2010 1.6; 2011 3.1; 2012 2.2; 2013 1.7. - Federal balance (percent of GDP, fiscal years): 2007 -1.2; 2008 -3.2; 2009 -11.6; 2010 -9.7; 2011 -9.0; 2012 -7.5; 2013 -6.0. - Debt held by the public (percent of GDP): 2007 36.3; 2008 40.5; 2009 54.1; 2010 62.8; 2011 67.7; 2012 73.0; 2013 77.1. - Current account balance (percent of GDP): 2007 -5.1; 2008 -4.7; 2009 -2.7; 2010 -3.0; 2011 -3.1; 2012 -3.1; 2013 -2.9. - Three-month Treasury bill rate (percent): 2007 4.5; 2008 1.4; 2009 0.2; 2010 0.1; 2011 0.1; 2012 0.1; 2013 0.1. - Ten-year government bond rate (percent): 2007 4.6; 2008 3.7; 2009 3.3; 2010 3.2; 2011 2.8; 2012 2.1; 2013 2.8. *Source: UNITED STATES 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND (Selected excerpts).* ### 1. United States: Selected Economic Indicators __________________________________________________ 45 ### 1. United States: Selected Economic Indicators ### Backdrop: Still a Fragile Recovery - Growth and labor - Growth decelerated to around 2 percent in the first half of 2012 after rebounding in the second half of 2011. - Job creation slowed considerably since April 2012 after being surprisingly strong in late 2011 and early 2012. - Employment-to-population ratio remains about 4 percentage points below its level in December 2007. - Over 40 percent of the unemployed have been out of work for over six months. - Household sector and housing - Net worth-to-disposable income ratio for the household sector is now slightly above pre-housing boom levels, but the majority of households remain well below pre-boom net-worth ratios due to depressed house prices and elevated debt. - Middle-income households have made limited progress in increasing net worth through saving (Selected Issues Paper Chapter I). - House prices increased in February, March, and April 2012, but risk of further declines remains significant given large “shadow” inventory (underwater, delinquent, re-performing, and REO properties). - Foreclosures continue to impose high costs through adverse impacts on house prices and household wealth. - Housing starts have been rising since 2011Q3; starts in 2012Q1 were more than 20 percent higher than a year earlier, but remain at only about one half of their 1990s average. - Staff estimates an excess supply of housing will be absorbed gradually as household formation normalizes (Selected Issues, Chapter II). - Business sector and trade - Business fixed investment lost momentum starting in 2011Q4 despite low borrowing costs and high profit margins; partial phasing out of accelerated depreciation incentives in January 2012 may have pulled some investment forward into 2011. - Net exports failed to add to growth over the last two quarters; imports rebounded but exports decelerated through 2011 and showed signs of weakness in April and May 2012. - The dollar appreciated 7 percent in real terms between its July 2011 trough and June 2012. - Current account deficit: edged up to 3.1 percent of GDP in 2011 and widened to 3.6 percent of GDP in 2012Q1. - Fiscal and monetary backdrop - U.S. general government deficit was about 9½ percent of GDP in 2011. - Fiscal impulse turned negative in 2011 for the first time since the financial crisis; the GG structural primary deficit fell by ¾ percent of GDP in 2011. - Fiscal policy remained a drag in 2012Q1 (declining defense spending, downsizing at state and local governments, scaling back of corporate investment incentives), while some supportive measures were extended through 2012 (payroll tax cut and emergency unemployment benefits). - Federal Reserve actions (to respond to weak growth with policy at the zero lower bound): - August 2011: FOMC guidance anticipating exceptionally low federal funds rate at least through mid-2013. - January 2012: guidance that low rates likely warranted at least through late 2014. - September 2011: “Operation Twist” — purchases up to $400 billion in Treasury securities with 6–30 year maturities and sales of an equal amount of securities with maturities of 3 years or less (to be completed by June 2012); reinvestment of principal payments on agency debt and MBS into agency MBS. - June 20, 2012: continuation through end-2012 of a program to extend the average maturity of securities holdings (sales/redemptions of about $267 billion in shorter-term securities and purchases of longer-maturity Treasury securities of an equal amount by end-2012); once completed, the Fed will hold almost no securities maturing through January 2016. - Estimated effects of Fed actions: - Estimated reduction in ten-year Treasury yields of some 60 basis points. - Common elasticities imply a 60 basis point decline in the ten-year yield is equivalent to a federal funds rate easing of some 150 basis points, with a growth impact of roughly 0.3 percentage points for each of the next two years. - Policy actions have also postponed market expectations of the start of policy tightening and lowered mortgage interest rates, albeit by less than declines in Treasury and MBS yields. - Inflation and wages - Headline CPI: peaked at 3.8 percent in September 2011; declined to 1.7 percent in May 2012. - Core CPI has hovered around 2 percent. - Wage inflation was 1.4 percent (year-on-year) in May 2012. - Long-term inflation expectations remain stable; the Fed announced a formal 2 percent inflation goal in January 2012. ### Transmission, Credit, and Financial Sector - Mortgage market frictions - Large declines in long-term rates have been less effective in stimulating mortgage refinancing because of high loan-to-value ratios, tighter credit standards, and rigidities in the mortgage market. - Mortgage refinancing volumes and passthrough to disposable income and consumption have been constrained. - Financial conditions - Despite very low long-term rates, obstacles to refinancing have limited the boost to aggregate demand. - The Fed’s securities holdings provide an amount of “effective easing” broadly consistent with historical relationships between the federal funds rate and inflation/unemployment gaps (Rudebusch-Taylor rule). ### Outlook and Risks (Staff Projections and Assumptions) - Growth projections - Staff projects GDP growth of 2 percent in 2012 and 2.3 percent in 2013. - Key baseline assumptions - Households will continue balance sheet repair; house prices expected to bottom out around mid-2012 and increase very slowly thereafter, providing limited support to net worth. - Bank credit conditions for households and small businesses are expected to ease only slowly, keeping consumption growth subdued. - GG structural primary balance projected to improve by 1 percent of GDP in 2012, subtracting about ½ percentage point from growth. - Baseline for 2013 envisages a relatively modest reduction in the GG structural primary balance of 1¼ percent of GDP, reflecting expiring stimulus measures (payroll tax cut), decline in war-related spending, and an assumption that expiring Bush tax cuts and other revenue provisions are extended fully for one year with tax cuts for upper-income taxpayers assumed to expire from 2014. - Automatic spending cuts (the “sequester”) are expected to be replaced by other back-loaded measures in staff’s baseline. - Monetary conditions expected to remain accommodative with policy tightening beginning around late 2014 and a gradual unwinding of the Fed’s securities holdings starting in early 2014. - Private investment in equipment and software expected to expand more slowly than in early recovery but remain a strong contributor to growth. - Residential investment projected to start adding to growth from 2012 onwards after six consecutive years of negative contributions. - Stronger dollar and weaker global demand projected to weigh on exports; net international trade expected to subtract from growth over 2012–2017. - Weaker oil prices will partly offset negative impacts on the current account. - Headline and core inflation projected to remain subdued and reach the Fed’s 2 percent medium-term goal only in the medium term. - Labor market forecast - Unemployment rate projected to decline slowly to 7.9 percent in 2013. - Long-term unemployment will likely remain elevated and may lag aggregate unemployment improvements. *Source: UNITED STATES 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND (Selected excerpts).* ### 14. Risks to the outlook remain tilted to the downside. Risks are both external, particularly ### _cr12213 - 14. Risks to the outlook remain tilted to the downside. Risks are both external, particularly ### Major downside risks - Risks remain tilted to the downside, both external (notably a worsening of global conditions from the euro area debt crisis) and domestic (notably an impasse on the debt ceiling and a failure to reach an agreement on near-term tax and spending policies, which would trigger a “fiscal cliff”). - Over the medium term, failure to adopt a plan that would help achieve fiscal sustainability would raise risks. ### External risks: euro area debt crisis and spillovers - Trade channel - Lower demand in the euro area would reduce U.S. exports to the region (which account for about 15 percent of overall U.S. exports or 2 percent of GDP). - Renewed financial turmoil would likely be accompanied by U.S. dollar appreciation on safe-haven flows, further dragging on exports. - Example scenario: a two percentage point drop in euro area growth accompanied by a 5 percent real effective appreciation of the dollar could reduce U.S. GDP by between ¾ and 1 percentage point over a two-year horizon. - Generalized market contagion - Intensified euro area turmoil could raise risk aversion and lower asset prices. - A bout of financial stress similar to July–November 2011 could reduce U.S. real GDP by about 0.6 percentage point over two years (based on VAR-based FCI simulations and a one standard deviation permanent shock). - Pressure on money market mutual funds (MMMFs) - MMMFs have been major investors in liabilities of euro area banks; prime MMMFs’ exposure to the core euro area has halved over the last year but remains material. - Distress at a large euro area bank could trigger a run on MMMFs, hampering wholesale funding and severely affecting the U.S. financial system and U.S. nonfinancial firms. - Deleveraging by EU banks - April 2012 GFSR “weak EU policies” scenario projected a reduction of some US$230 billion in U.S. assets held by EU banks. - Claims by EU banks on the United States fell by $170 billion during 2011Q4, but this did not translate into a decline in U.S. bank credit; commercial and industrial loans expanded in 2011Q4 and 2012Q1 by about $30 billion and $45 billion, respectively. - U.S. activities shed by EU banks have been picked up by U.S. banks or other foreign banks; EU banks’ claims include loans to non-U.S. entities. - Stock market valuation channel - U.S. multinational firms with substantial sales in the euro area could see profitability and stock-market valuations affected by euro area turmoil. ### Domestic risks: fiscal cliff, debt ceiling, and medium-term sustainability - Fiscal cliff - If all temporary tax provisions expire and automatic spending cuts take effect, the 2013 fiscal contraction would be very sizable (over 4 percent of GDP). - This “fiscal cliff” would reduce annual growth to around zero, and the economy would contract in early 2013. - Anticipatory effects: CBO estimates spending held back by policy uncertainty could subtract perhaps ½ percent from (annualized) growth in the second half of 2012. - Debt ceiling - The federal debt ceiling will need to be raised most likely in early 2013, risking heightened uncertainty and financial market disruption with potential negative confidence effects and market reactions. - Medium-term fiscal sustainability - Failing to agree on a credible medium-term plan could erode the reserve currency status of the U.S. dollar and put upward pressure on Treasury yields. - Despite legislated deficit reduction measures, the public debt ratio remains on an unsustainable trajectory (Annex II). ### Upside risks - Pent-up demand could support recovery: - Strong nonfinancial corporate balance sheets could yield stronger-than-expected capital investment in a less uncertain environment. - Housing: pent-up demand for housing and increased demand for rental units could lead to faster recovery of housing starts. Staff estimate: one hundred thousand additional housing starts by end-2013 could lead to an increase in GDP growth of 0.2 percent in 2012 and 2013. - A slower fiscal withdrawal than in the baseline, if embedded in a credible medium-term consolidation framework, would help lift growth. ### Policy discussion: sustaining recovery and reducing vulnerabilities - Focus areas - Appropriate pace, timing, and composition of fiscal consolidation. - Room and need for further monetary policy easing. - Additional measures to unclog housing markets and reduce risks from persistently high long-term unemployment. - Progress and remaining challenges in financial regulatory reform. - Fiscal consolidation framework - Adoption of a credible consolidation framework is crucial for stable medium-term growth. - Budget Control Act caps discretionary spending; failure of the Congressional Committee on Deficit Reduction led to scheduled deep automatic spending cuts (“sequester”) starting in 2013. - Overall savings from discretionary caps and sequester: $2.1 trillion over 10 years, but still insufficient to stabilize the debt ratio. - Staff recommendation: replace automatic cuts with specific, back-loaded measures generating equal savings; agree on an ambitious and comprehensive consolidation framework to stabilize the public debt ratio by mid-decade and put it on a downward path. - A medium-term primary surplus of at least 1 percent of GDP would help achieve debt stabilization even if interest rates rebound. - IMF staff consider the medium-term growth assumptions in the administration’s fiscal proposals to be optimistic and above IMF, CBO, and Consensus projections. - Composition of consolidation - With discretionary spending capped and defense outlays projected to fall, attention must shift to entitlements (the key driver of long-term spending) and revenue increases due to low U.S. tax ratio. - Political difficulties expected; authorities noted bipartisan agreement likely depends on election results. ### Entitlement spending: health care and public pensions - Health care - Ongoing implementation of the 2010 health care reform; CMS Innovation Center launched pilot programs (including expanding primary care, bundled payments, Accountable Care Organizations) affecting about 50,000 health care providers. - These initiatives potentially slow long-term cost growth; staff urged aggressive implementation. - State-level health insurance exchanges delayed, but authorities believed federal government could set up exchanges in lagging states. - June 2012 Supreme Court ruling upheld most Affordable Care Act provisions but limited federal ability to mandate Medicaid expansion at the state level. - Staff suggested considering additional savings in the health sector: raising fees, tightening eligibility (e.g., raising Medicare eligibility age), trimming health-related tax expenditures. - Authorities’ budget proposal envisages about $360 billion in new health care-related savings over 10 years, with measures affecting beneficiaries backloaded toward the end of the decade. - Public pensions (Social Security) - Staff view: Social Security imbalances warrant early parametric reform (modest increase in retirement age, modified benefit structure to increase progressivity, higher annual ceiling for contributions). - Social Security Trustees report: combined trust funds could run out of resources in 2033—three years earlier than projected last year—requiring a 25 percent cut in scheduled benefits if unaddressed. Disability Insurance trust fund could be depleted in 2016. - No specific reform proposal included in the President’s February budget; President has called for bipartisan talks to address Social Security sustainability. *Source: _cr12213 - 14. Risks to the outlook remain tilted to the downside. Risks are both external, particularly* ### 22. Revenues could be raised through a broad menu of options, including lower tax ### 22. Revenues could be raised through a broad menu of options, including lower tax ### Revenues and tax reform - Personal tax expenditures amount to some 7 percent of GDP and disproportionately benefit high-income households. - Options to raise revenues discussed: - Curbing personal tax expenditures within a fundamental tax reform package (described as growth- and distribution-friendly). - Introduction of a VAT and carbon taxes (Box 4). - Higher marginal personal income tax rates. - Improving corporate taxation: broadening the base, lowering marginal rates (the United States has the highest statutory corporate tax rate in the OECD), and achieving a more efficient tax treatment of multinational enterprises. - Authorities indicated repeated proposals to let the Bush tax cuts for high-income taxpayers expire and to limit tax deductions for these taxpayers. - Staff cautioned that reforms affecting taxation of foreign activities by U.S. corporations require appropriate consideration of possible international spillovers. - Selected Issues Chapter VI discusses implications of alternative options, including the President’s framework for corporate tax reform unveiled in February. ### Pace and composition of fiscal consolidation - Staff recommended a measured pace of deficit reduction given persistent weakness in economic activity. - The President’s FY2013 budget proposal envisages a reduction in the federal deficit by 3 percent of GDP in FY2013 (from 8½ percent to 5½ percent of GDP) due to expiring stimulus, revenue-raising measures, and some defense savings. - CBO estimate: the President’s budget proposal would imply only a 2 percent of GDP adjustment, in part because the budget overstates spending this year; Congressional inaction on certain stimulus proposals could lower the FY2013 withdrawal below 2 percent of GDP if implemented. - Staff suggested targeting a federal deficit of about 6¼ percent of GDP for FY2013—¾ percentage point of GDP higher than planned in the President’s budget proposal—appropriate given the weak outlook and downside risks. - This target would be consistent with a reduction in the general government structural primary deficit of around 1 percent of GDP in calendar year 2013. - Deficit reduction should be as growth-friendly as possible, prioritizing: - Infrastructure spending. - Training programs to limit skill mismatches. - Housing initiatives. - Further extension of emergency unemployment benefits. ### State and local governments (SLGs) - SLGs continued fiscal adjustment; balanced-budget rules and phase-out of federal aid subtracted about ¼ percent from GDP growth last year. - State and local employment showing signs of stabilization, but risks remain from weak housing market and property tax collections. - Rebuilding of rainy-day funds stopped this fiscal year; most states plan some progress in FY2013, but reserves in about half of the states remain well below prudent levels. - Some states have trimmed contingent liabilities from pension and health care obligations, but these liabilities remain sizeable. - Private analysts estimate unfunded pension liabilities in a wide range of $1–4 trillion. - Authorities hoped forthcoming modification of GASB standards would create further incentives for SLGs to address unfunded pension liabilities. ### Monetary policy - Fed’s unconventional actions since the crisis supported activity and hedged against deflationary risks; inflation expectations remain well anchored. - Staff argued that slow unemployment reduction and downside risks may call for further easing in the second half of the year (discussions occurred before the June 20 easing action). - The President/authorities viewed the risks to the outlook as tilted to the downside; argued costs of downside scenarios likely exceed costs of stronger-than-expected outcomes. - Very low long-term interest rates might limit benefits from further accommodation. - Effectiveness of asset purchases: - Operation Twist and forward guidance lowered long-term yields. - Asset purchases may have greater impact in unsettled market conditions (when arbitrage is imperfect, liquidity premia are high, and risk spreads are elevated). - First large-scale asset purchase program was introduced under severely dislocated markets and eased conditions substantially; subsequent smaller programs were also effective. - Mortgage market frictions (limited competition and capacity constraints among servicers, high-loan-to-value borrowers unable to refinance, tighter lending standards) have weakened pass-through of lower MBS yields into mortgage rates, but staff and authorities agreed lowering longer-term yields still positively affects aggregate demand. - Additional tools for easing: - Staff argued additional MBS purchases would be a particularly promising option given the high share of long-maturity Treasury securities held by the Fed and housing’s importance to the outlook. - Authorities noted tension between further MBS purchases and the FOMC’s desire to return to an all-Treasury portfolio. - Effectiveness of MBS purchases would be enhanced by policy actions expanding access to mortgage refinancing. - Fed contingency in case of intensified global turmoil: - Dollar liquidity swap lines with foreign central banks are authorized through February 2013 to ease strains in dollar funding markets. - Under the Dodd-Frank Act (DFA), Fed’s ability to provide institution-specific support is limited, but it retains authority to establish broadly-available liquidity facilities to stabilize funding conditions if appropriate. ### Housing policy and measures to support the market - Measures taken since last year showing early positive effects: - Expansion of Home Affordable Refinancing Program (HARP) for loans owned or guaranteed by the GSEs. - Strengthening of Home Affordable Modification Plan (HAMP), including elimination of debt service-to-income cutoffs and tripling of incentives for investors to carry out principal reductions under HAMP’s Principal Reduction Alternative (PRA). - October 2011 HARP expansion appears to have led to a significant increase in HARP refinancing; share of loans with principal reductions under HAMP has been rising. - State Attorneys General Settlement with major banks could lead to up to $34 billion of principal reduction and has led banks to delay foreclosures and increase substitution with short sales. - Evidence cited: - Foreclosed properties estimated to sell at around a 27 percent discount and lower the value of neighboring properties by around 2 percent. - Staff recommended more aggressive actions to accelerate housing recovery; specific policy measures discussed: - Supporting mortgage modifications: - Encourage GSE participation in principal reduction programs. - Forceful implementation of HAMP expansion, including incentives for servicers to participate. - Shared appreciation mechanisms to allow lenders and borrowers to share future house price gains; authorities agreed on usefulness but noted technical constraints. - Existing program forces participating second-lien holders to reduce second-lien principal by equal proportion to first lien; incentives for extinguishing second-lien principal have been increased. - Supporting refinancing on a larger scale: - Current refinancing volumes are low relative to historically low mortgage rates; barriers to refinancing clog monetary transmission. - Administration proposals include easing frictions hindering cross-servicer refinancing and expanding the program to non-GSE borrowers; these measures are contained in three bills recently introduced in Congress (authorities’ note). - Facilitating conversion of foreclosed properties into rental units: - FHFA pilot program could reduce negative price impact of foreclosures by averting distressed sales; timely expansion recommended, though technical challenges may delay implementation. - Allowing mortgages to be modified in personal bankruptcy courts (“cramdowns”): - Implementing cramdowns would align treatment of primary residences with most other secured debt and create incentives for voluntary modifications at no fiscal cost (Selected Issues Chapter VII). - Authorities acknowledged arguments for cramdowns but noted lack of sufficient political support. ### Labor market challenges and policies - Cyclical factors explain most current labor market weakness, but risk exists that structural unemployment may rise without policy action. - Long-term unemployment is at 3.5 percent of the labor force and remains elevated compared with previous recessions. - Elevated long-term unemployment risks loss of human capital and labor force attachment, possibly lowering participation rate or raising NAIRU. - Apparent shift in the Beveridge curve for some industries (especially manufacturing) may indicate skill mismatches. - Recent and proposed measures: - Job Creation Act of February 2012: extension of payroll tax cuts through 2012; requirement that recipients of long-term unemployed benefits take up job search services and training/education services. - Administration proposals not approved by Congress include: - American Job Act of 2011: one-year reduction in the portion of the payroll tax paid by employers for incremental payroll increases; a $4,000 credit to employers for hiring long-term unemployed workers. - 2013 Budget: active labor market policies including Pathways Back to Work program subsidizing employment for low-income youth and long-term unemployed; a 10 percent tax credit for new jobs and wage increases. *UNITED STATES 2012 ARTICLE IV REPORT — INTERNATIONAL MONETARY FUND* ### 35. Staff was supportive of these measures, and suggested that tax incentives could be ### _cr12213 - 35. Staff was supportive of these measures, and suggested that tax incentives could be ### Labor market measures and policy advice - Staff supported targeted tax incentives for employment creation and recommended more resources for programs that help the long-term unemployed return to work. - Staff suggested tax incentives aimed at the long-term unemployed deserve more consideration, given these individuals’ higher risk of human capital losses. - Staff cautioned against an abrupt reduction of the maximum duration of extended unemployment benefits, noting these provide an important social safety net amid protracted labor market weakness. - Ensuring adequate funding for active labor market policies (training and support for job search) was emphasized, with evidence that these measures improve employment prospects of long-term unemployed workers. - Finding: Resources for active labor market policies in the United States are generally lower than other OECD countries, and have fallen since 2007 as a ratio to the long-term unemployed. ### Financial sector conditions — banking system outlook - Authorities viewed the U.S. banking system outlook as broadly positive. - Finding: Earnings growth for the U.S. banking sector has been positive over the last 11 quarters; losses and bank failures peaked in late 2010. - Regional stresses persist: Arizona, California, Florida, Georgia, and Nevada continue to suffer higher rates of bank failures tied to exposures to weak house prices and construction activity, notably commercial real estate. - Banks report weak loan demand from small and medium enterprises (SMEs) reflecting weak demand and declined collateral following the housing bust. - Mortgage credit supply remains tight; the Fed’s Senior Loan Officer Opinion Survey shows almost no easing of mortgage standards since the crisis. - A large backlog of troubled mortgages, regulatory uncertainty, and scaled-down real estate lending operations weigh on banks’ willingness and ability to supply mortgage credit. ### Risks from global financial stresses - Staff expressed concerns about vulnerabilities of the largest U.S. banks to stresses emanating from euro area turmoil, given large derivative portfolios (including euro area counterparties) and relatively high dependence on wholesale funding. - Observation: Increase in CDS spreads for the largest U.S. banks over recent months could reflect contagion concerns from renewed global financial market turmoil. - Authorities cited stress testing from the second Comprehensive Capital Analysis Review (CCAR) as giving reassuring indications on resilience of the largest U.S. banks to very severe shocks. - Authorities acknowledged that severe shocks to large core euro area banks would have negative repercussions for U.S. financial institutions but noted time to adjust exposures and prepare contingency plans. - Footnote data: Self-reported data on the six largest U.S. banks (Bank of America, JPMorgan, Citigroup, Morgan Stanley, Goldman Sachs and Wells Fargo) suggest aggregate net exposure to peripheral Europe (taking into account protection purchased and the full set of collateral) was about US$57 billion at end 2011. Counterparty risk remains a concern as about 75 percent of all CDS trading globally is concentrated amongst 20 major banks/brokers that include the five major U.S. banks. ### Shadow banking and market structure - Authorities noted continued depressed activity in segments of the shadow banking system, unlikely to return to pre-crisis levels in the foreseeable future. - Money market mutual funds (MMMFs): - Finding: The MMMF asset base—US$2.5 trillion—is about one third below its end-2008 peak. - Risk: Runs on MMMFs following distress in a large euro area bank remain a potential risk. - Mitigation: Prime MMMFs halved exposure to the core euro area to about US$215 billion in May 2012 and shortened duration. - Private-label securitization remains well below pre-crisis levels nearly four years after the crisis peak: - Issuance of CDOs has evaporated; private-label RMBS issuance has slowed to a trickle. - Authorities attributed this to weak housing market, unresolved regulatory reforms (including risk retention rules), and tight credit rating standards for structured paper. - Some foreign broker-dealers relinquishing U.S. bank holding group status raised staff questions about expansion of the U.S. shadow banking system; authorities noted continued SEC supervision, potential SIFI designation, applicability of the Volcker Rule when parent institutions have U.S. bank branches/agencies/subsidiaries. ### Insurance companies and defined-benefit pension funds - Staff underscored challenges from a low interest rate environment for insurance companies and defined-benefit pension funds. - Finding: Low interest rates boost present value of future pension liabilities. - Official estimate: Corporate pension underfunding was about $700 billion as of 2010, concentrated in airlines, auto, and steel. - Society of Actuaries: Employers have generally funded plans in advance of requirements, but rising required contributions in coming years could create difficulties for weaker companies. - Insurance industry: 2011 stress tests were reassuring that insurers would maintain adequate capital ratios even if interest rates stayed low for long. - Risk: A spike in global financial stress could cause downgrades of counterparties in derivative contracts, potentially triggering contract unwinds or novation requirements under specific state derivative use laws. ### Progress on financial reform implementation - Authorities reported continued progress implementing the financial reform program under the Dodd-Frank Act and international regulatory reform agenda, but noted the volume of rulemaking and limited resources slowed finalization. - Areas of achieved progress: - SIFIs and FMUs: Final rules on submission of resolution plans (“living wills”), criteria for designation of non-bank SIFIs and Financial Market Utilities; initial rulemakings for orderly liquidation authority promulgated; FMU designation nearly complete; non-bank designation at earlier stage. Staff urged acceleration to identify and address systemic risks. - OTC derivatives: Groundwork laid for mandatory centralized clearing and improved transparency; coordination internationally emphasized; U.S. closer to implementation than other jurisdictions. Staff encouraged rapid finalization of rules. Consensus on need for strong CCP supervision and access to Fed liquidity in appropriate circumstances for systemically important CCPs. - Basel rules: Final rules issued to increase capital buffers for trading book and securitization activities broadly following Basel 2.5 (U.S. banks continue to report capital ratios under Basel I). Initial rulemaking proposals issued to require greater and higher quality capital buffers in line with Basel III. - Timeline and details preserved by authorities: - Final rule on Basel III standards expected around timeline agreed with the Basel Committee (January 2013). - Dodd-Frank Act provision on greater capital buffers for systemically important banks (assets above $50 billion) will be implemented at the same time as the capital surcharge for the Global Systemically Important Banks (G-SIBs) (between 2016 and 2018). - Implementation of Basel liquidity standards: Liquidity Coverage Ratio implementation will not begin until 2015; Net Funding Stable Ratio implementation will not begin until 2018. - Staff welcomed progress and encouraged further rulemaking to fully implement the Basel III framework in line with the internationally agreed timeline. ### Areas requiring further work to increase resilience - Regulation of the shadow banking system: - Need more progress on regulation of MMMFs given size, role in short-term funding, and susceptibility to runs. - Options to mitigate MMMF risks include moving from stable to floating net asset values, imposing capital requirements, and redemption limits. - Need to reduce systemic risk from tri-party repo market’s dependence on intraday credit provided by clearing banks, following tri-party repo task force recommendations. - Volcker Rule: - Staff view: A ban on proprietary trading could reduce risk of significant losses on banks’ derivatives positions, but effectiveness depends on balancing interpretation—too rigid could push activities outside regulatory perimeter; too expansive exemptions could dilute the ban. - Importance of minimizing adverse international spillovers and impact on market liquidity. Authorities aim for an appropriate definition of market-making activities to address concerns. - Insurance regulation: - Staff reiterated concern that lack of a national regulatory framework complicates coordination across state regulators for domestic and international reform. Authorities pointed to establishment of the Federal Insurance Office (FIO) at the Treasury as a significant step forward. - Mortgage market reforms: - Staff urged quick completion of risk retention regulation requiring banks that securitize loans to retain a share of the risk to reduce uncertainty weighing on private securitization recovery. - Under law, a bank must retain an ownership interest in any mortgage it securitizes if that mortgage does not meet the new requirements of a Qualified Residential Mortgage (QRM). - The Consumer Financial Protection Bureau (CFPB) is still reviewing comments on the Qualified Mortgage (QM) proposed rules that would impose underwriting standards to ensure borrowers have the ability to repay. - Authorities noted other frictions affecting banks’ appetite for mortgage lending, including capacity constraints and risks from representations and warranties. - Future of the GSEs: - Staff stressed the need to balance supporting housing market recovery and enacting structural reforms to reduce the role of the GSEs over the medium term (as envisaged in a 2011 Administration report to Congress). - Authorities noted need for broad consensus on reforms and flagged FHFA’s strategic plan outlining next phase of conservatorships. Staff and authorities agreed on a medium-term strategy to reduce GSE role to encourage shift toward private institutions. ### Systemic oversight and resources - Strong oversight of systemic risk requires coordination across fragmented U.S. regulatory architecture. - Authorities noted the Financial Stability and Oversight Council (FSOC) has greatly improved coordination and cooperation among agencies; FSOC sub-committees and working groups meet frequently. - The Office of Financial Research (OFR) can support agencies via a centralized database on institutions’ positions and exposures and by developing a dashboard for systemic risk indicators. - Funding needs: Rapid completion and effective implementation of new regulations require adequate funding for regulatory and supervisory agencies. - Authorities report agencies face budgetary constraints limiting their ability to meet deadlines for domestic and international reforms. - Staff argued lifting these resource constraints should be a priority to ensure effective monitoring once new regulations come into force. ### The United States and the world economy - Staff emphasized that policy actions to raise savings over the medium term (including restoring fiscal sustainability) and to strengthen the short-term recovery would contribute importantly to global growth and stability. - With household saving rates projected to remain close to current levels in the medium term, higher public savings would help ensure the U.S. current account deficit remains moderate as domestic investment gradually recovers. - Restoring fiscal sustainability would reduce potential future risks to external stability from a potential decline in foreign demand for U.S. debt securities that could trigger sharply higher U.S. interest rates with adverse global spillovers. *United States 2012 Article IV Report — excerpts as provided* ### 45. The authorities agreed on the need for the U.S. to raise its saving rate, particularly ### _cr12213 - 45. The authorities agreed on the need for the U.S. to raise its saving rate, particularly ### Global rebalancing and U.S. saving rate - Authorities agreed on the need for the U.S. to raise its saving rate, particularly through fiscal consolidation. - They expressed concern that weaker global demand could drag down world growth. - Decisive action to forestall the risk of a euro area crisis, boost demand, and increase currency flexibility in surplus countries was seen as essential to revive world growth and achieve global rebalancing, in line with goals of the G-20 Framework for Strong, Sustainable, and Balanced Growth. - Such policy actions would improve the outlook for U.S. exports and the current account, facilitating rotation from domestic demand to external demand. - Authorities expect the U.S. bond market to remain deep, liquid, and attractive to foreign investors. ### U.S. current account, external position, and exchange rate - The U.S. current account deficit narrowed after the crisis but the external position remains weaker than justified by fundamentals and desired policies. - The U.S. net International Investment Position (NIIP) reached -27 percent of GDP at end-2011. - Staff projections and model-based estimates: - The cyclically-adjusted current account deficit is 1–2 percentage points of GDP weaker than the value implied by fundamentals and desirable policies. - The real effective exchange rate is moderately overvalued (0–15 percent), also reflecting recent appreciation of the dollar. - The current account deficit is expected to widen modestly in the next few years as the output gap gradually closes, thus increasing imports, but lower oil prices feed through. - Medium-term staff scenario: - Fiscal consolidation aiming for a primary surplus of at least 1 percent of GDP, accompanied by some depreciation of the dollar and desired policies in partner countries, would allow for a strengthening of the current account balance of the order of 1–2 percent of GDP relative to staff’s projections. - Such an outcome would be in line with maintaining external stability and full employment. - Authorities broadly concurred with staff’s current account projections but did not take a view on the appropriateness of the level of the current account balance and the dollar. ### Fiscal cliff risk and global spillovers - Staff warned that materialization of the fiscal cliff would have negative effects on other economies: - If the tail risk of the fiscal cliff materializes, the U.S. economy would at a minimum stall next year, with growth turning negative in early 2013. - Spillovers would mostly propagate through trade channels, with negative effects stronger in immediate neighbors (Canada and Mexico) and smaller but non-negligible impacts in advanced Europe and Japan. - Spillovers to emerging markets would be more manageable given lower sensitivity to U.S. growth, higher trend growth, and larger policy flexibility; however, models may understate effects via lower commodity prices and export-related investments, and sizable financial market reactions could greatly amplify shocks. - Authorities were confident a political agreement would be reached to avoid drastic fiscal tightening in 2013. ### Monetary policy actions and international spillovers - U.S. monetary policy easing has helped sustain the U.S. recovery and supported global growth, but has spillovers: - Easing tends to be accompanied by declines in interest rates in other countries, dollar depreciation, and U.S. capital outflows, though quantifying effects is difficult due to anticipation, coincident shocks, and global events. - Staff findings: - Mixed evidence on the impact of recent U.S. monetary policy easing on foreign interest rates and exchange rates, reflecting that easing often coincided with a material worsening of the global outlook (which tends to strengthen the U.S. dollar via safe-haven flows). - U.S. investors have significantly reduced their purchases of foreign bonds since the onset of the financial crisis, despite the dramatic decline in U.S. interest rates. - Destination shifts: U.S. residents reduced purchases of euro area and U.K. bonds and boosted purchases of bonds issued by Australia, Canada, and Latin America (in addition to increasing holdings of U.S. Treasuries). - Staff estimate: innovative tools adopted by the Fed over the past year have reduced 10-year Treasury bond yields by some 60 basis points. - Authorities’ view: - Declining interest rates would have contributed to higher bond outflows, ceteris paribus, but monetary easing occurred in response to weak growth and an unsettled global environment where high risk aversion, flight to safety, and demand for liquidity were key drivers. - Fundamental reasons exist for capital to flow to emerging markets; destination changes also reflected changes in relative growth prospects and cyclical positions post-crisis. ### Trade policy and market access - Mission welcomed authorities’ commitment to trade liberalization and market access to support growth and jobs. - Given slower progress in multilateral trade frameworks, short-term focus shifted to plurilateral and bilateral agreements: - Pursuing Trans-Pacific Partnership engagements and possible talks with the EU. - Continued work on FTA issues with Panama following FTAs with Colombia and Korea. - Addressing industrial policies of trading partners, and IPR and technology protection under bilateral investment treaties based on the revised model BIT. - Staff welcomed efforts to resist protectionist pressures and encouraged aiming for multilateral trade liberalization, including new approaches as necessary. ### Housing market, labor market, and structural policies - Housing market actions: - Authorities expanded mortgage modification and principal reduction programs and eased some refinancing frictions. - Staff supports timely and aggressive implementation, including GSE participation in principal reduction and servicer adherence to loosened eligibility criteria. - Additional recommended steps: facilitate conversion of foreclosed properties into rental units; support access to refinancing on a larger scale; consider allowing mortgages to be modified in personal bankruptcy courts. - Labor market concerns: - Long-term unemployment is significantly above levels seen in previous recessions and has declined relatively little since the start of the recovery, raising risks of human capital loss and lower participation. - Recommended policies: adequately fund active labor market policies (training and job-search support); consider temporary tax incentives to expand labor demand, particularly targeted toward the long-term unemployed. ### Financial sector reforms and supervision - Progress welcomed in implementing the Dodd-Frank Act and global financial reforms: - Final rules on “living wills” for SIFIs; orderly liquidation authority; designation criteria for SIFIs; enhanced capital standards aligned with Basel 2.5 as of January 2013; near-implementation of centralized clearing of OTC derivatives. - Remaining vulnerabilities and priorities: - Strengthen regulation of money market mutual funds given industry size and susceptibility to runs, especially as the emergency backstop facility is no longer available. - Reduce systemic risk from the tri-party repo market’s dependence on intraday liquidity from clearing banks. - Monitor Volcker rule implementation to avoid expansive exemption interpretations and migration of risky activities outside the regulatory perimeter; minimize adverse spillovers on foreign entities and market liquidity. - Remove uncertainty around the risk-retention provision of Dodd-Frank to encourage gradual recovery of private securitization and ease mortgage market conditions. - Fully articulate a medium-term strategy to reduce the role of GSEs to encourage a shift toward private institutions in the mortgage market. - Supervisory and regulatory capacity: - Some agencies face budgetary constraints that limit their ability to meet reform deadlines and to effectively monitor markets once new regulations come into force; lifting these constraints is a high priority. ### Staff appraisal and policy recommendations - Main policy challenge: use limited policy space to support near-term recovery while restoring fiscal sustainability with a balanced medium-term consolidation and completing financial sector reforms. - Immediate fiscal recommendations: - Remove uncertainty from the “fiscal cliff” and promptly raise the debt ceiling. - Pursue a pace of deficit reduction that does not sap the economic recovery; consider temporary extension of current policies if a bipartisan agreement is not reached. - Staff’s recommended pace of adjustment would be consistent with a federal deficit of about 6¼ percent of GDP for FY2013—some ¾ percentage point of GDP higher than planned in the President’s budget proposal. - This implies a contraction of the general government structural primary deficit of around 1 percent of GDP in calendar year 2013. - Spending composition should be growth-friendly, emphasizing high-multiplier policies: infrastructure spending; training programs; housing initiatives; further extension of emergency unemployment benefits. - Raise the federal debt ceiling well ahead of the deadline to reduce uncertainty and avoid confidence and financial market disruptions. - Medium-term fiscal consolidation: - Agree early on a comprehensive plan to stabilize the public debt ratio by mid-decade and put it on a downward path thereafter. - Target a medium-term primary surplus of at least 1 percent of GDP to stabilize the debt ratio even factoring in a significant rebound of interest rates. - Replace deep automatic spending cuts under the Budget Control Act (the “sequester”) with specific, back-loaded measures generating at least an equal amount of savings. - Revenue and entitlement reform: - Medium-term consolidation should include revenue-raising measures and reforms to slow entitlement spending growth. - Implement cost-saving provisions of health care reform and phase in additional saving measures gradually. - Social Security imbalances warrant early parametric reform. - Given the budget deficit, age-related spending pressures, and relatively low tax ratio, include higher revenues via options including: - Lower tax expenditures (which amount to some 7 percent of GDP and disproportionately benefit high-income taxpayers). - Introduction of a VAT and carbon taxes. - Higher marginal personal income tax rates. - Improve corporate taxation structure through base-broadening, lowering marginal rates, and more efficient tax treatment of multinationals. - Monetary policy stance: - Monetary policy appropriately remains very accommodative, with some room for further easing if the outlook deteriorates. - Fed actions welcomed, including extending maturity of securities holdings and considering additional net MBS purchases; Fed innovations reduced 10-year Treasury yields by some 60 basis points. - If global financial turmoil intensifies, the Fed should be ready to intervene with emergency liquidity facilities. - Multilateral coordination: - A multilateral approach is critical for systemic countries like the United States, whose policy actions have significant cross-border effects. - U.S. fiscal consolidation would be consistent with rebalancing global demand together with increased domestic demand in surplus countries as highlighted in the G-20 Mutual Assessment Process. - Coordinated progress on financial reforms across jurisdictions to align key regulations and standards would be globally beneficial and reduce regulatory arbitrage. *Italic: UNITED STATES 2012 ARTICLE IV REPORT — INTERNATIONAL MONETARY FUND* ### 62. We welcome the authorities’ efforts to resist protectionist pressures, while facing a ### _cr12213 - 62. We welcome the authorities’ efforts to resist protectionist pressures, while facing a ### Trade policy and multilateral obligations - Authorities are commended for resisting protectionist pressures amid a challenging domestic and global economic environment. - Recommendation: continue to ensure consistency of domestic legislation and practices with WTO principles and international obligations, including in reforms of agricultural support programs. - Recommendation: aim for multilateral trade liberalization, including new approaches as necessary. - Note: The next Article IV consultation is scheduled to take place on the standard 12-month cycle. ### Financial conditions in the United States (Box 1) - Aggregate trajectory: - Staff’s Financial Condition Index tightened in the last quarter of 2011 and eased in early 2012. - Tightening in late-2011 driven by higher credit spreads, weaker asset valuations, and appreciation of the dollar, offsetting easing in U.S. banks’ lending standards suggested by surveys. - Early-2012 easing driven by lower stress in global financial markets (tighter spreads, higher asset valuations); overall bank lending standards broadly unchanged. - Sectoral differences: - Large corporates: - Credit conditions continue to be quite accommodative. - Corporates are "flush with cash" and have easy access to bond finance; banks expanded commercial and industrial loans. - Small- and medium-sized businesses: - Credit conditions less favorable. - Banks’ SME lending portfolio is still 15 percent below its peak in 2008. - Small- and medium-sized businesses rely on personal residence as collateral and face difficulties obtaining credit as the value of home collateral remains low. - Recent surveys suggest weak demand for credit is driven by concerns about sales and profit outlook rather than access constraints. - Households: - Credit conditions remain tight. - Consumer loans (credit cards, auto loans) are stabilizing. - Tight mortgage lending conditions have curtailed credit extended to borrowers. - New borrowers’ credit scores are higher for both prime and FHA mortgages relative to pre-crisis years. - Unresolved housing issues—shadow inventory, foreclosures, regulatory reform—continue to weigh on banks’ appetite and capacity for lending. - Shadow banking and mortgages: - “Shadow” banking system reduction affected credit creation, especially mortgages. - Decline in home mortgages from about $11 trillion in 2007 to about $10 trillion in 2011 roughly mirrors the $1 trillion decline in the private-label MBS market. - Volume of GSE-backed MBS is still close to pre-crisis levels. - By contrast, corporate bond issuance rose over the same period. ### Effects of recent U.S. monetary policy actions (Box 2) - Fed policy measures: - FOMC announced in August 2011 it anticipated exceptionally low federal funds rates at least through mid-2013; in January 2012 extended the period to late-2014. - September 2011: Fed restarted net purchases of MBS and launched “Operation Twist” (OT), entailing purchases of up to $400 billion in U.S. Treasuries with maturities above 6 years by June 2012, matched by sales of shorter-term securities. - Impact on long-term yields and risk assets: - Event studies: - Ten-year Treasuries fell 22 basis points in the days following the announcement. - 30-year Treasury and agency MBS yields dropped by 30–40 bps. - Prices of riskier assets (stock markets and oil prices) declined sharply and the U.S. dollar appreciated; VIX rose reflecting increased market uncertainty. - Regression analysis: - Estimated decline of 11–50 basis points in the ten-year Treasury rate based on the increase in the Fed’s share of long-term government securities since the OT announcement (through 2012Q1). - Forward guidance effects: - 10-year Treasury yields fell by a combined 34 bps in the days following FOMC statements. - 30-year government securities and MBS dropped 20–48 bps. - Stock markets rose and investment-grade yields fell somewhat; U.S. dollar reaction was mixed (depreciating only following the January announcement). - Effects on mortgage rates: - Immediate OT announcement effect: 30-year mortgage rate fell 7 basis points. - By end-2011 mortgage rates had fallen by 15–20 basis points, partially reflecting the Fed’s MBS purchases. - Mortgage rates dropped 10–17 basis points following each of the forward guidance announcements; drop more modest than for 30-year MBS yields, likely reflecting supply constraints and limited competition. ### Health of the U.S. banking system (Box 3) - Overall assessment: - Major U.S. bank holding companies (BHCs) have strengthened balance sheets amid a challenging environment (low rates, uncertain macro and regulatory outlook, financial volatility, legal problems). - Most systemic banking institutions performed favorably in the authorities’ Spring 2012 Comprehensive Capital Analysis and Review (CCAR) stress test. - Ongoing challenges: large European exposures, credit rating downgrades, uncertain earnings outlook, investor concerns from disclosure of a major trading loss. - Share prices are low and default risk measures are elevated. - Earnings and revenues: - For full-year 2011, all but one of the 19 CCAR institutions posted positive pre-tax net income. - Banks’ earnings are on average lower than in the pre-crisis period for top 4 BHCs, traditional banks, and other major BHCs. - Securitization revenues have been low since the crisis; provisioning expenses have supported earnings but reserve coverage is low by historical standards. - Trading revenues have increased in prominence at top 4 BHCs and traditional banks, contributing to volatility. - Capitalization improvements: - Total equity to total assets rose to 9.6 percent in the first quarter of 2012, from a low of 7.5 percent in the third quarter of 2008. - Tier 1 common capital ratio improved from 5 percent at end-2008 to 10.9 percent as of March. - Actions taken by major BHCs: - Reduced or suspended common dividends during 2008–09; two-thirds of publicly traded institutions increased distributions as profitability and capital positions improved. - New common equity offerings at CCAR BHCs have totaled more than $160 billion since 2009. - Redeemed trust preferred securities and replaced them with common equity in some cases. - Total assets grew about 10 percent since end-2009 while risk-weighted assets decreased 2.8 percent; ratio of risk-weighted assets to total assets fell to 57 percent at CCAR institutions. - Staff estimate: CCAR BHCs would need to raise about $230 billion in capital if they were to achieve their March tier 1 common capital ratios with a share of risk-weighted assets in total assets in line with historical norms. - De-risking more aggressive at BHCs with more depressed share prices relative to 2007. - CCAR stress-test outcomes: - Exercise covered 19 largest BHCs under stressed scenarios through end-2013. - Results: one bank failed to meet the required Tier 1 capital minimum of 5 percent; an additional three institutions missed required thresholds on basis of their proposed capital distribution plans. - The Fed approved the capital distribution plans of 15 of the 19 institutions; the majority of those outlined increased dividends, share buyback programs or both. - Market-based measures and investor concerns: - Share prices for the 6 largest U.S. banks remain below their post-Lehman highs. - CDS spreads for the 6 largest BHCs have been ratcheting up recently to levels well above post-Lehman lows. - Rise in spreads reflects concerns about funding structures, exposures to Europe, expected rating actions, and global financial institution worries. ### Meeting environmental and fiscal objectives with a carbon tax (Box 4) - Rationale and global risk: - Atmospheric accumulations of CO2 and other greenhouse gases could raise temperatures by up to 6.5 degrees of Celsius over pre-industrial levels by 2100, with substantial risks to the global economy. - A carbon tax provides incentives to reduce emissions and invest in energy-efficient and renewable technologies. - Policy proposal and effects: - The U.S. Interagency Working Group recommended a carbon tax of about $20 per metric ton of CO2. - Such a tax could be raised by about 2–5 percent annually in real terms, cutting emissions by 5–15 percent. - The carbon tax could raise about $100 billion annually, or 0.6 percent of GDP. - Imposing the tax could somewhat reduce economic growth in the short term; negative medium-term effects should be very modest, especially if new revenues are used to reduce the national debt or partly lower other taxes. - Mitigation measure: grant U.S. companies tax credits for purchasing emission offsets abroad to mitigate negative effects and support financial flows to developing countries. - Administration and scope: - The tax can be applied upstream to the carbon content of fossil fuel products, as an extension of existing motor fuel taxes. - Tax administration would primarily involve approximately 150 petroleum refineries, 500 large natural gas operators, and about 1,500 coal mines. - Motor fuels should not be exempt from the carbon tax; current fuel taxes (which should continue) undercharge for negative side effects of vehicle use such as road congestion and local pollution. - Distributional effects and mitigation: - A $20 carbon charge would increase gasoline prices by about 18 cents a gallon, electricity prices by 1 cent per kWh, and coal prices by $40 per short ton. - Carbon charges tend to be regressive; low-income households could be compensated through transfer payments, earned income tax credits, and higher personal tax thresholds costing less than 10 percent of carbon tax revenues. - Energy-intensive, trade-exposed firms could be granted transitory production subsidies. *International Monetary Fund. UNITED STATES 2012 ARTICLE IV REPORT — content unit _cr12213 - 62.* ### Box 5. Recent Housing Policies and Remaining Frictions ### Box 5. Recent Housing Policies and Remaining Frictions ### Programs, scope, and recent outcomes - The Administration launched the Making Home Affordable (MHA) program in March 2009, which included two key components: the Home Affordable Refinance Program (HARP) and the Home Affordable Modification Program (HAMP). - HAMP activity: 1.8 million modifications have been initiated under HAMP as of May 2012 (since the program started in April 2009); only one million of these were made permanent. - HARP activity: HARP has reached only around a million borrowers. - Program expansions and changes: - October 2011: The FHFA expanded HARP by removing restrictions on very high loan-to-value (LTV) loans, lowering the refinancing fees charged by the GSEs, and easing representations and warranties. - Q1-2012: Average monthly HARP refinancing has been around 75 percent higher than its average in 2011. - As of June 2012: Eligibility criteria for HAMP were loosened by allowing households with lower debt service-to-income ratios to participate, and incentives for investors to carry out principal reductions under HAMP-PRA were tripled. These incentives were also extended to the GSEs. - The Federal Housing Finance Agency (FHFA) is expected to make a final decision on the GSEs’ participation in HAMP; the participation of the GSEs would increase the impact of the program given their market share. ### Remaining barriers and frictions limiting program effectiveness - Refinancing frictions: - The October 2011 easing of representations and warranties applies only to same-servicer refinancing; refinancing with another servicer (cross-servicer refinancing) remains very challenging for high LTV borrowers. - Lack of cross-servicer competition has been a major contributing factor to weak refinancing activity. - HAMP-specific frictions contributing to disappointing results: - Misalignment of incentives of investors and servicers: modifications can be, in some cases, more costly to servicers than foreclosures. - Conflicts of interest between senior and junior lien holders; the “Second Lien Modification Program” attempts to address this problem. - Legal frictions due to ambiguities in the Pooling and Servicing Arrangements, which can limit modifications both explicitly and implicitly. ### Administration proposals and likely effects - Proposed expansions: - Ease representations and warranties on cross-servicer refinancing to encourage competition on the refinancing market. - Extend HARP-like access to low-cost refinancing for non-GSE mortgages through the FHA. - Legislative and administrative prospects: - Three recently proposed bills aim at implementing these proposals, but approval by Congress is uncertain. - If approved by Congress, the proposed changes would likely lead to a significant increase in refinancing. - If rejected by Congress, the FHFA has the authority to implement the proposed changes for the GSE market. *Source: Box 5, UNITED STATES 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND.* ### Box 8. The U.S. External Sector: Trends and Model-Based Assessments (continued) ### Box 8. The U.S. External Sector: Trends and Model-Based Assessments (continued) ### Model-based current account and exchange rate assessments - Staff analysis finds that a structural current account deficit of 1½–2½ percent of GDP over the medium term would be consistent with fundamentals and desirable policy settings. - This implies a current account adjustment of 1–2 percent of GDP relative to the staff baseline. - A real exchange rate depreciation of about 0‒15 percent would be consistent with fundamentals and desirable policy settings. ### Model comparisons and quantitative findings - Under the External Balance Approach (EBA): - Estimates of “policy gaps” imply a current account gap for the United States of around 2 percent of GDP. - Under CGER current account methodologies (e.g., MB and ES approaches): - Current account gaps are found to be around 1-2 percent of GDP. - Real exchange rate model estimates (EBA and CGER): - Tend to find little sign of overvaluation, in the 0 to 5 percent range. - Measures of relative international price levels (WARP): - Find U.S. prices relative to trading partners closer to their long-run average and could be consistent with somewhat higher overvaluation given weak fundamentals. - Current-account based methodologies for real exchange rate misalignment: - Produce estimates in the 5–15 percent range. - Overall model-based range for real exchange rate misalignment: - About 0–15 percent. ### Implications and interpretation - Multiple methodologies point to a current account deficit above its medium-term norm, with typical model-based current account gaps clustering around 1–2 percent of GDP. - Estimates for real exchange rate misalignment vary across approaches: - Price-level based indicators (WARP) and EBA/CGER real exchange rate models suggest small overvaluation (0–5 percent). - Current-account based methods point to larger misalignments (5–15 percent). - Combining these results yields an overall model-based misalignment range of about 0–15 percent. - Policy-relevant quantitative targets implied by the analysis: - Reduce the current account deficit toward a structural deficit of 1½–2½ percent of GDP (requiring an adjustment of 1–2 percent of GDP from the staff baseline). - Allow for real exchange rate depreciation in the range of 0‒15 percent to restore consistency with fundamentals. *Source: Box 8. The U.S. External Sector: Trends and Model-Based Assessments (continued), UNITED STATES 2012 ARTICLE IV REPORT.* ### ANNEX I. UNITED STATES: DOWNSIDE RISK ASSESSMENT MATRIX ### ANNEX I. UNITED STATES: DOWNSIDE RISK ASSESSMENT MATRIX ### Downside risks: nature, likelihood, and expected impact - Overall: Four principal downside threats identified with assessed likelihoods and impacts. - 1. “Fiscal cliff” - Overall level of concern: Low - Nature/Source: Political gridlock could trigger a much larger fiscal withdrawal than envisaged in the baseline scenario. - Likelihood of severe realization in the next 1–3 years: High - Expected impact if realized: High — "A fiscal consolidation of over 4 percent of GDP in 2013 would reduce annual growth to around zero." - 2. Lack of medium term plan for fiscal consolidation - Overall level of concern: Low - Nature/Source: Failure to agree on a credible plan to put the federal debt on a sustainable medium-term path could lead to a gradual erosion of the reserve currency status of the U.S. dollar and upward pressure on Treasury bond yields. - Likelihood of severe realization in the next 1–3 years: High - Expected impact if realized: High — "Loss of confidence and higher interest rates would undermine the recovery of private domestic demand, and have severe financial market repercussions, domestically and internationally, given the central role played by US Treasuries in global financial markets." - 3. Weaker housing market - Overall level of concern: Low - Nature/Source: Faster-than-anticipated transitioning of units in foreclosure into distressed sales. - Likelihood of severe realization in the next 1–3 years: Medium - Expected impact if realized: Medium — "A 10 percent decline in house prices relative to the baseline would subtract about 0.3 percent from 2013 growth." - 4. Contagion from Euro area debt crisis - Overall level of concern: Medium - Nature/Source: A significant worsening of the euro area debt crisis may affect the United States through trade and financial channels. - Likelihood of severe realization in the next 1–3 years: Medium - Expected impact if realized: Medium — "Impact would occur through the trade channel, and a tightening of financial conditions, including stress in MMMFs." ### Key fiscal consolidation measures enacted and timing - Congress has legislated about $2.1 trillion in medium-term fiscal consolidation measures. - Budget Control Act (August 2011) effects: - Capped discretionary spending, saving about $900 bn over 10 years relative to the CBO baseline. - Will trigger automatic appropriations cuts (“sequester”) worth $1.2 trillion over 10 years; unless modified by Congress, the cuts are scheduled to come into effect in January 2013. ### Debt trajectory, staff baseline, and recommended policy posture - Despite legislated savings, U.S. public finances remain on an unsustainable trajectory under staff’s baseline. - Debt projections: - "Federal debt held by the public is projected to increase from about 70 percent of GDP now to around 85 percent of GDP in FY2022." - "General government gross debt approaching 120 percent of GDP by CY2021." - Interest-rate environment and debt-stabilizing primary balance: - Current low interest rates have substantially improved fiscal projections; real interest rates have fallen well below GDP growth. - As a result, "the debt-stabilizing primary balance is currently negative" and will remain so over the standard 5-year DSA horizon despite projected increases in Treasury yields. - Staff recommendation: - "Aiming for a medium-term primary surplus of at least 1 percent of GDP would be appropriate to put the public debt ratio firmly on a downward path, while building a sufficient margin for the higher interest costs of public debt." - Note: "the targeted primary surplus would be even higher in the long run to bring the debt ratio closer to the pre-crisis levels by 2030." ### Sensitivity analysis, scenarios, and key stress assumptions - Public debt dynamics are highly sensitive to growth and interest rate assumptions, reflecting that the U.S. public ratio already exceeds 100 percent of GDP (general government gross debt context). - Scenario and shock design notes: - Individual shocks are permanent one-half standard deviation shocks (interest rates also considered with a 2 standard deviation shock). - Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance in other tests. - A standard 10 percent of GDP shock to contingent liabilities is assumed to occur in 2013 in a contingent-liabilities scenario. - Historical scenarios use ten-year historical averages to project debt dynamics five years ahead. - Example scenario outcomes (Annex Figure summaries): - Growth shock, primary balance shock, interest rate shock, combined shock, contingent liabilities shock, and no policy change scenarios all raise public debt trajectories relative to the baseline (baseline public debt noted as 113 percent of GDP in figure labels). - Figures in boxes in Annex Figure represent average projections for the respective variables in the baseline and scenario being presented; ten-year historical average for the variable is also shown. ### Selected quantitative tables and projection highlights (Annex Table and assumptions) - Baseline: Public sector debt (percent of GDP) - 2007: 67.2 - 2008: 76.1 - 2009: 89.9 - 2010: 98.4 - 2011: 102.8 - 2012: 106.7 - 2013: 110.7 - 2014: 112.7 - 2015: 113.0 - 2016: 113.0 - 2017: 112.8 - Change in public sector debt (percent of GDP) - 2007: 0.5 - 2008: 9.0 - 2009: 13.7 - 2010: 8.6 - 2011: 4.4 - 2012: 3.9 - 2013: 4.0 - 2014: 2.0 - 2015: 0.3 - 2016: 0.0 - 2017: -0.2 - Identified debt-creating flows (percent of GDP) - Primary deficit (includes interest receipts): 2012: 5.4; 2013: 3.9; 2014: 2.1; 2015: 1.0; 2016: 0.7; 2017: 0.3 - Revenue and grants including interest receipts: 2012: 31.5; 2013: 32.9; 2014: 33.8; 2015: 34.6; 2016: 34.9; 2017: 34.7 - Primary (noninterest) expenditure: 2012: 36.9; 2013: 36.8; 2014: 35.9; 2015: 35.6; 2016: 35.6; 2017: 35.1 - Automatic debt dynamics (contribution): 2012: -1.1; 2013: -1.0; 2014: -1.5; 2015: -2.1; 2016: -2.1; 2017: -1.9 - Contribution from real interest rate: 2012: 0.9; 2013: 1.4; 2014: 1.5; 2015: 1.5; 2016: 1.5; 2017: 1.7 - Contribution from real GDP growth: 2012: -2.0; 2013: -2.3; 2014: -3.0; 2015: -3.6; 2016: -3.7; 2017: -3.6 - Other identified debt-creating flows: 2012: -0.5; 2013: 1.1; 2014: 1.0; 2015: 1.0; 2016: 1.0; 2017: 1.0 - Residual (including asset changes): 2012: 0.1; 2013: 0.0; 2014: 0.3; 2015: 0.3; 2016: 0.4; 2017: 0.4 - Public sector debt-to-revenue ratio (percent) - 2007: 198.0 - 2008: 234.2 - 2009: 290.5 - 2010: 311.0 - 2011: 323.2 - 2012: 338.6 - 2013: 336.6 - 2014: 333.4 - 2015: 326.6 - 2016: 323.8 - 2017: 324.6 - Scenario snapshots - Scenario with key variables at their historical averages: 2012: 106.7; 2013: 111.4; 2014: 116.4; 2015: 121.4; 2016: 126.6; 2017: 131.8 - Scenario with no policy change (constant primary balance) in 2012-2017: 2012: 106.7; 2013: 112.2; 2014: 117.5; 2015: 122.1; 2016: 126.7; 2017: 131.4 - Key macroeconomic and fiscal assumptions underlying baseline (selected) - Real GDP growth (in percent) - 2007: 1.9 - 2008: -0.3 - 2009: -3.5 - 2010: 3.0 - 2011: 1.7 - 2012: 2.0 - 2013: 2.3 - 2014: 2.8 - 2015: 3.3 - 2016: 3.4 - 2017: 3.3 - Average nominal interest rate on public debt (in percent) - 2007: 4.7 - 2008: 4.3 - 2009: 3.4 - 2010: 3.2 - 2011: 3.1 - 2012: 2.8 - 2013: 2.8 - 2014: 2.9 - 2015: 3.1 - 2016: 3.3 - 2017: 3.7 - Average real interest rate (nominal rate minus change in GDP deflator, in percent) - 2007: 1.8 - 2008: 2.1 - 2009: 2.3 - 2010: 2.0 - 2011: 0.9 - 2012: 1.0 - 2013: 1.4 - 2014: 1.5 - 2015: 1.5 - 2016: 1.5 - 2017: 1.6 - Inflation rate (GDP deflator, in percent) - 2007: 2.9 - 2008: 2.2 - 2009: 1.1 - 2010: 1.2 - 2011: 2.1 - 2012: 1.8 - 2013: 1.4 - 2014: 1.4 - 2015: 1.6 - 2016: 1.9 - 2017: 2.1 - Growth of real primary spending (deflated by GDP deflator, in percent) - 2007: 3.9 - 2008: 7.5 - 2009: 9.7 - 2010: -1.9 - 2011: -0.6 - 2012: -2.1 - 2013: 1.9 - 2014: 0.3 - 2015: 2.5 - 2016: 3.3 - 2017: 1.8 *Source: _cr12213 - ANNEX I. UNITED STATES: DOWNSIDE RISK ASSESSMENT MATRIX (2012 Article IV Report), International Monetary Fund* ### 1. This note reports on information that has become available since the staff report ### _cr12213 - 1. This note reports on information that has become available since the staff report ### Recent macroeconomic data and growth outlook - Annualized real GDP growth is estimated at 1.5 percent for the second quarter, marginally lower than staff’s projection of 1.7 percent and lower than the 2 percent growth estimated for the first quarter. - The deceleration was largely due to a slowdown in private consumption growth, likely reflecting the run up in gasoline prices through April, and slower job creation and lower income expectations in the face of growing uncertainty. - National accounts revisions released on July 27th indicate that growth was lower in 2010 and higher in 2011 than previously thought. - Growth is likely to remain moderate in 2012 and 2013, constrained by household deleveraging, fiscal restraint, and subpar global demand. - Projections and outlook notes: - Private investment in equipment and software projected to expand at a slower pace but remain a strong contributor to growth. - Residential investment projected to start making positive contributions to growth after six consecutive years of declines. - A stronger dollar and weaker global demand projected to weigh on exports. - Headline and core inflation projected to remain subdued, reaching the Federal Reserve’s 2 percent goal over the medium term. - Downside risks have intensified, including from the euro area debt crisis and uncertainty over domestic fiscal plans. ### Financial stability, FSOC actions, and regulatory reports - On July 18, 2012, the Financial Stability Oversight Council (FSOC) designated eight financial market utilities as systemically important, subjecting them to Fed supervision and heightened prudential standards. - The designated utilities perform a variety of functions, including the clearing and settlement of cash, securities, and derivatives transactions. - FSOC published its second annual report on July 18, 2012; the U.S. Treasury’s Office of Financial Research issued its inaugural annual report on July 20th. - The potential threats to U.S. financial stability identified in these reports are largely in line with those highlighted in the Staff Report. ### Financial conditions and banking sector performance - Financial conditions do not appear to have changed noticeably since the end of the consultation, despite intensified financial stresses in the euro area. - Second-quarter earnings for major U.S. financial institutions were mostly above expectations, mainly as lower provisioning expenses offset the negative impact of lower trading profits, sluggish loan growth, and low interest rates. - The pick-up in mortgage refinancing activity under the Home Affordable Refinancing Program has boosted revenues. - CDS spreads on major U.S. banks and equity prices for financial institutions remain around their end-June levels. - The outlook for the U.S. banking system is broadly positive but subject to risks from an intensification of stresses in global financial markets. ### Fiscal policy developments and analytical reports - Congressional Budget Office and Joint Committee on Taxation analysis of the Supreme Court ruling on health care reform: - Because states can choose whether to expand Medicaid eligibility, it is projected that about 3 million more people than initially estimated will remain uninsured once the reform is implemented. - This implies lower federal government spending (around $84 billion over a decade). - Task force headed by Richard Ravitch and Paul Volcker highlighted problems with state and local budgets: - Unfunded pension and health care liabilities. - Lack of transparency in accounting practices. - Many task force recommendations align with staff recommendations (see Selected Issues Paper “Fiscal Challenges Facing the U.S. State and Local Governments” (IMF Country Report No. 11/202)). ### IMF Executive Board assessment and policy recommendations - Executive Directors welcomed the continuing moderate recovery and noted downside risks from external and domestic uncertainties. - Key Director recommendations and assessments: - Use limited policy space effectively to support the recovery in the near term and restore medium term fiscal sustainability with a balanced approach to consolidation. - Adopt a measured pace of deficit reduction that does not sap the recovery. - Removing the uncertainty created by the “fiscal cliff” in 2013 and promptly raising the debt ceiling are critical. - Agree as early as possible on a comprehensive medium term fiscal consolidation plan, based on both higher revenues and lower entitlement spending, that would stabilize the debt ratio by mid decade and gradually reduce it afterwards. - Monetary policy should remain highly accommodative for quite some time; most Directors see room for further easing should the outlook deteriorate, though some note limited effectiveness in a very low interest rate environment. - Some Directors highlighted potential adverse global spillovers of very low interest rates through capital flows and higher commodity prices. - Welcome recent actions and proposals to bolster the housing market; urged timely and aggressive implementation and consideration of further measures, including: - Facilitating conversion of foreclosed houses into rental units. - Allowing mortgages to be modified in personal bankruptcy courts. - Facilitating refinancing on a larger scale. - Support for training and job-search support funding and temporary tax incentives to help reduce long term unemployment. - Commendation for progress on domestic and international financial reforms and emphasis on increasing financial system resilience: - Strengthen regulation of money market mutual funds. - Finalize the Volcker Rule with due consideration of cross border implications. - Accelerate adoption of Basel III capital rules. - Wind down the role of government-sponsored entities. - Strengthen coordination of financial sector regulation and supervision and allocate appropriate resources to regulatory and supervisory agencies. - Stress importance of a multilateral approach to economic policy management and the United States adopting a credible medium term plan for fiscal consolidation at a pace that does not undermine the recovery. ### Key statistics and selected economic indicators (annual change in percent, unless otherwise indicated) - Real GDP: 2007 1.9, 2008 -0.3, 2009 -3.5, 2010 3.0, 2011 1.7, 2012 2.0 (projection), 2013 2.3 (projection) - Net exports (contribution to real GDP growth): 2007 0.6, 2008 1.2, 2009 1.1, 2010 -0.5, 2011 0.0, 2012 -0.1, 2013 -0.2 - Total domestic demand: 2007 1.2, 2008 -1.5, 2009 -4.4, 2010 3.4, 2011 1.6, 2012 2.0, 2013 2.3 - Private final consumption: 2007 2.3, 2008 -0.6, 2009 -1.9, 2010 2.0, 2011 2.2, 2012 2.2, 2013 2.3 - Gross fixed domestic investment: 2007 -1.4, 2008 -5.1, 2009 -15.2, 2010 2.0, 2011 3.7, 2012 4.8, 2013 6.8 - Residential structures: 2007 -18.7, 2008 -23.9, 2009 -22.2, 2010 -4.3, 2011 -1.3, 2012 10.4, 2013 12.8 - Unemployment rate: 2007 4.6, 2008 5.8, 2009 9.3, 2010 9.6, 2011 9.0, 2012 8.2, 2013 7.9 - CPI inflation: 2007 2.9, 2008 3.8, 2009 -0.3, 2010 1.6, 2011 3.1, 2012 2.2, 2013 1.7 - Federal balance (percent of GDP, fiscal years): 2007 -1.2, 2008 -3.2, 2009 -11.6, 2010 -9.7, 2011 -9.0, 2012 -7.5, 2013 -6.0 - Debt held by the public (percent of GDP): 2007 36.3, 2008 40.5, 2009 54.1, 2010 62.8, 2011 67.7, 2012 73.0, 2013 77.1 - Gross debt (percent of GDP, general government): 2007 67.2, 2008 76.1, 2009 89.9, 2010 98.4, 2011 102.8, 2012 106.7, 2013 110.7 - Three-month Treasury bill rate (percent): 2007 4.5, 2008 1.4, 2009 0.2, 2010 0.1, 2011 0.1, 2012 0.1, 2013 0.1 - Ten-year government bond rate (percent): 2007 4.6, 2008 3.7, 2009 3.3, 2010 3.2, 2011 2.8, 2012 2.1, 2013 2.8 - Current account balance (billions of dollars): 2007 -710, 2008 -677, 2009 -382, 2010 -442, 2011 -466, 2012 -491, 2013 -479 - Current account balance (percent of GDP): 2007 -5.1, 2008 -4.7, 2009 -2.7, 2010 -3.0, 2011 -3.1, 2012 -3.1, 2013 -2.9 - Merchandise trade balance (billions of dollars): 2007 -819, 2008 -830, 2009 -506, 2010 -645, 2011 -738, 2012 -769, 2013 -817 - Gross national saving (percent of GDP): 2007 14.6, 2008 13.4, 2009 11.5, 2010 12.5, 2011 12.9, 2012 13.3, 2013 14.1 - Gross domestic investment (percent of GDP): 2007 19.6, 2008 18.0, 2009 14.7, 2010 15.8, 2011 15.9, 2012 16.4, 2013 17.1 *Source: IMF staff note and Public Information Notice (PIN) No. 12/93, August 2, 2012.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12213.pdf_