## _cr14221

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### How Reversible is the Decline in U.S. Labor Force Participation?
- Key indicators and context:
  - LFPR fell by around 3 percentage points since 2008.
  - LFPR at June stood at 62.8 percent (its lowest level since 1978).
  - LFPR reached an all-time high of 67.3 percent in 2000.
  - Unemployment rate reached 6.1 percent in June amid decent job growth and declining participation.
- Drivers (staff analysis):
  - Structural and cyclical factors jointly explain the decline:
    - Demographics (population aging and delayed retirement): demographic models suggest aging explains around 50 percent of the LFPR decline since 2007.
    - Cyclical factors (job availability): state-level panel regressions suggest cyclical effects account for a further 30–40 percent of the decline.
  - Other contributors:
    - Youth participation: share of students working fell from 43 to 37 percent since 2007.
    - Disability insurance: applications rose after the recession; acceptance rates have fallen but the share receiving disability insurance has risen due to aging and applicants often exit the labor force while applications are pending.
- Reversibility and outlook:
  - Up to one-third of the post-2007 decline is reversible (staff analysis).
  - Timing:
    - Over the next 2–3 years a temporary respite in the secular decline is expected as cyclical conditions improve.
    - After this interim period participation rates are expected to start declining again as population aging dominates.
  - Implication: partial reversal will support near-term growth; longer-run demographic forces imply continued downward pressure.

### Domestic risks to the baseline and macroeconomic implications
- Domestic risk drivers:
  - Baseline growth forecast subject to uncertainties; earlier slowdown could be more permanent.
  - Interest rates could rise more rapidly due to an unanticipated Fed shift or markets unwinding compression in volatility, term premia, and credit spreads.
  - Rapid rise in rates could instigate financial volatility harming U.S. growth; prolonged low rates could build systemic risks.
  - Return of fiscal uncertainties in 2015 (debt limit or budget disputes) would create downside risks.
  - Delaying credible medium-term fiscal consolidation could precipitate loss of confidence and higher sovereign risk premium.
- Global spillovers from U.S. developments:
  - A one percentage point increase in the U.S. term premium could reduce growth in the rest of the world by around 0.2 percent.
  - Low-probability, high-impact U.S. bond market distress could generate peak world output loss of 3.4–6.0 percent.
- External risks to U.S. recovery:
  - A one percentage point fall in emerging market growth could lower U.S. growth by 0.1 percent over a year.
  - Geopolitical tensions could cause U.S. growth to fall by up to 0.2–0.8 percent in 2014–15 depending on severity and longevity.

### Poverty, labor income policies, and policy measures to support the poor
- Scale:
  - Almost 50 million Americans were living in poverty in 2012 (Census Bureau supplemental poverty measure).
  - Official poverty rate stuck at about 15 percent since the recession.
- Policy priorities:
  - Expand the Earned Income Tax Credit (EITC) for workers without dependents, low-income youth, and older workers not yet eligible for social security.
  - Make permanent the 2009 extensions (EITC to larger families, mitigation of the “marriage penalty”, increase and refundability of the Child Tax Credit) due to expire in 2017.
  - Complement EITC expansion with an increase in the federal minimum wage to ensure firms bear part of the cost and to avoid EITC lowering pre-tax wages.
- President’s 2015 Budget proposals highlighted:
  - Doubling the childless worker EITC.
  - Making younger adult workers eligible for the EITC.
  - Requiring federal contractors to pay at least $10.10 per hour and calling on Congress to raise the minimum wage to $10.10 for all workers.
- Minimum wage context:
  - As of June 1, 2014, 22 states and the District of Columbia have minimum wages above the federal minimum.
  - In 2012, 3.6 million hourly paid workers had wages at or below the federal minimum wage of $7.25 per hour; a further 13 million earn below $10 per hour.
  - U.S. minimum wage is 37.8 percent of the median wage; OECD average is 47.1 percent of the median wage.
- Box 3 selected fiscal cost estimates (staff calculations):
  - Make permanent 2009 EITC/CTC extensions: 97.4 billion ($ over 10 years); 0.04 percent of GDP; increase of about 40 percent of average after-tax income for poor households; reduction in official poverty rate: 6.8–0.5 percentage points.
  - Double maximum EITC for individuals without dependents and expand to ages 21–24: 59.7 billion; 0.03 percent of GDP; increase of about 20 percent of average after-tax income; reduction in official poverty rate: 4.4–0.4 percentage points.
  - Raise federal minimum wage from $7.25 to $10.10: employment effect decrease of about 500 (thousands); fiscal cost negligible in table; 2.6–0.3 percent of average after-tax income; reduction in official poverty rate: figures in table.
  - Combination of all measures: 146.9 billion; 0.06 percent of GDP; employment decrease of about 400 (thousands); increase in take-home pay for poor households of 9.7–1.0 percent of average after-tax income.

### Productivity, potential growth pressures, and policy priorities
- Key pressures:
  - Potential growth expected to level off at around 2 percent in the coming years, below pre-crisis average of over 3 percent.
  - Labor force expansion expected to be below ½ percent per year, half the average growth rate seen in 2000–13 and below the 1.2 percent average over the past 30 years.
  - Labor productivity: staff forecast assumes non-farm business sector output per hour worked rebounds from 0.5 percent in 2013 to around 1.6 percent by the end of the decade (compared with average 2¾ percent gains between 1998 and 2007).
- Policy priorities:
  - Infrastructure investment:
    - American Society of Civil Engineers estimates $200 billion (about 1.1 percent of GDP) needed from 2014 to 2020.
    - Provide clarity on financing of the Highway Trust Fund; sustain increased federal and state infrastructure spending paid for by savings in future entitlement outlays, additional revenues, and expanded financing sources including America Fast Forward Bonds.
    - Under America Fast Forward Bonds: federal subsidy payments would equal 28 percent of interest costs on bonds used to finance infrastructure projects and 50 percent if bonds are issued in 2014 and 2015 to finance building of schools.
  - Tax reform:
    - Comprehensive reform could raise real GDP by up to 1.6 percent over the next ten years.
    - Broaden bases, simplify, and reduce statutory tax rates for individual and corporate income tax.
  - Incentivize innovation and build skills:
    - Reinstate and make permanent the Research and Experimentation (R&E) tax credit (expired December 2013).
    - Improve state training programs, apprenticeships, vocational training, early childhood education (including universal pre-K), and STEM support.
  - Boost labor supply and reduce long-term unemployment:
    - Expand EITC and improve family benefits including childcare assistance.
    - Modify disability insurance to provide incentives for beneficiaries to work part-time.
    - Reach agreement on immigration reform to attract high-skilled workers.
    - Time-bound tax credits or wage subsidies for employers hiring the long-term unemployed.

### Box 4 — Productivity growth evidence from U.S. states
- Aggregate TFP growth slowed in the mid 2000s, before the financial crisis.
- State variation in change in TFP growth over 2005–10 (relative to 1996–2004):
  - Over 3 percentage points in New Mexico and South Dakota.
  - Below 1 percentage point in Washington, Oregon, Nebraska, Maryland, and others.
- Decomposition (stochastic frontier analysis):
  - Technological progress (shifts frontier upward) and technical efficiency (states moving closer to frontier).
  - Large variation in production efficiency across states.
- Determinants of efficiency:
  - Better human capital, higher R&D spending, and a more developed financial system correlate with higher efficiency.
- Panel regressions corroborate that higher educational attainment and greater R&D spending (especially government R&D) relate to higher TFP growth.

### Global spillovers, Fed communications, and operational issues
- Spillover channels and magnitudes:
  - If U.S. rate increases coincide with higher U.S. equity prices and better growth, they can be positive for other countries though vulnerabilities may persist.
  - If long-rate increases occur without growth improvement, likely outcomes include higher sovereign and corporate spreads, reversal of capital flows, lower asset prices, and a drag on EM growth.
  - Model estimates indicate second-round effects are likely empirically modest, though larger tail feedbacks remain possible.
- Authorities’ views:
  - Monetary policy will adapt to circumstances to achieve the Fed’s mandate.
  - Recent core PCE increase viewed mainly as transitory; inflation unlikely to return to 2 percent until wage growth outpaces labor productivity growth.
  - Authorities would not intentionally overshoot the inflation target.
- Communication enhancements proposed:
  - Schedule press conferences by the Fed Chair after each FOMC meeting.
  - Publish a quarterly monetary policy report endorsed by the FOMC conveying more detail on majority and dissenting views and plausible non-baseline scenarios.
  - Provide greater clarity on how financial stability considerations figure into monetary policy decisions.
- Exit and operational issues:
  - Current pace of tapering should be maintained, implying an end to asset purchases in late 2014 (staff view barring unforeseen developments).
  - Normalization of the Fed’s balance sheet should occur by letting assets mature; useful to provide a formal update of exit principles.
  - Use of overnight reverse repo and interest on excess reserves should allow a floor on market rates; could be complemented with term instruments.
  - Expansion in Fed counterparties for overnight reverse repo creates potential arbitrage; risks manageable via rate setting and caps.

### Financial system resilience, vulnerabilities, and policy recommendations
- Banking sector:
  - Tier 1 common equity ratio rose to 11.6 percent at end-2013 for the largest U.S. banks.
  - Recent Fed stress tests showed the 30 largest U.S. banks resilient to a severe domestic macro shock.
  - Capital plans rejected for five banks in CCAR; four rejected for qualitative internal control concerns.
  - Stress tests indicate large banks would face significant capital ratio declines and trading losses under severe global market shock.
  - Regulatory changes lower systemic risks but may weigh on future profitability; current return on equity remains well below pre-crisis averages.
  - Risk of profitability restoration via looser lending standards or longer asset durations implies need for intensive supervision.
- Insurance sector:
  - Risks from search for yield in prolonged low rate environment and ceding liabilities to off-balance-sheet reinsurance vehicles.
  - Supervision is fragmented; recommend coordinated national approach, more Federal Insurance Office role and resources, and nationally consistent stress testing and data.
- Mortgage availability and housing finance:
  - Tighter mortgage lending has constrained housing recovery, particularly for lower-rated borrowers.
  - Steps include safe harbor for Qualified Mortgages and clarifying put-back conditions.
  - Objectives for housing finance system:
    - Substantial first-loss risk borne by private capital.
    - Explicit public backstop limited to catastrophic credit losses with risk-based fees.
    - Regulatory agencies set underwriting standards and a common securitization platform.
  - Transition should be phased to avoid undermining recovery and private securitization restart.
- Corporate credit market risks:
  - Ample liquidity and low rates have encouraged refinancing, maturity extension, and rollovers.
  - Gross issuance of high yield bonds and loans in 2011–13 is more than double that in 2005–07.
  - Rising share of non-cash coupons, CCC ratings, covenant-lite loans, and second-liens; debt-to-earnings rising for leveraged borrowers.
  - Maturing credit cycle could increase defaults and lower recoveries.

### Nonbank intermediary risks and regulatory policy options
- Key vulnerabilities:
  - Growth of maturity and liquidity transformation through mutual funds and ETFs, particularly those investing in credit.
  - Nonbank flows to higher credit risk and longer-duration assets.
  - Uncertain leverage and risks in securities lending.
  - Decline in broker-dealer market making involvement.
- Disruptive scenario:
  - Abrupt unwinding of compressed volatility/risk pricing or a rise in short-term rates could trigger tail risk: investor exits, ETF/mutual fund outflows, market illiquidity, sharp losses for nonbanks, negative wealth effects lowering growth, corporate financing strains, and international knock-on effects.
  - Banking system would be robust but nonbanks could be dramatically affected.
- Regulatory and supervisory options:
  - Tighten underwriting for riskier commercial lending; higher risk weights or tighter large exposure limits for leveraged loans and high-yield bonds.
  - Strengthen prudential norms for holdings of securitized loans by regulated entities; consider additional capital charges on insurance companies.
  - Money market mutual funds: introduce floating NAV rules for prime funds; alternatives include stricter liquidity requirements or investment restrictions.
  - Tri-party repo: impose stricter haircuts and margins; develop mechanisms to counter fire-sale dynamics.
  - Too-important-to-fail and resolution: build on Dodd-Frank orderly resolution authority; finalize remaining rules; assess resolution plans against severe contingencies and progress cross-border cooperation.
  - Strengthen macroprudential framework: improve data sharing, clarify how Office of Financial Research monitoring translates into FSOC recommendations, and institute structured response processes to FSOC recommendations.
- FBO rule (Box 6) highlights:
  - By July 1, 2016 FBOs with more than $50 billion in U.S. subsidiaries must reorganize under an intermediate holding company (IHC).
  - Resulting IHC subject to a 3 percent Tier 1 leverage ratio and similar prudential liquidity standards as U.S. BHCs.
  - FBOs with assets between $10–50 billion subject to enhanced prudential standards.
  - FBOs account for 15 percent of total U.S. banking assets and approximately 40 percent of reserves held at the Fed.
  - Estimated capital shortfall (limited public data, year-end 2013): of 14 FBOs likely required to form IHCs, 4 fail the 3 percent Tier 1 leverage ratio; tentative total shortfall about $17.4 billion assuming zero retained earnings or asset sales before July 1, 2016.

### Housing finance, consultation timing, and selected macro projections
- Housing finance administrative recommendations:
  - Expand market transfers of first-loss risks from agencies to private investors.
  - Move gradually to higher, risk-based guarantee fees.
  - Steadily build up capital within agencies while reducing their role.
  - Establish a single securitization platform.
- Consultation timing:
  - Next Article IV consultation recommended on the standard 12-month cycle.
- Selected macro projections (staff projections and indicators, percent changes or levels as listed):
  - Real GDP (2012–2019): 2.8, 1.9, 1.7, 3.0, 3.0, 2.9, 2.8, 2.6.
  - Unemployment rate (2012–2019): 8.1, 7.4, 6.4, 6.0, 5.8, 5.6, 5.5, 5.5.
  - CPI inflation (2012–2019): 2.1, 1.5, 1.8, 1.8, 1.9, 2.0, 2.0, 2.0.
  - Ten-year government bond rate (2012–2019): 1.8, 2.4, 2.7, 3.3, 4.0, 4.5, 5.0, 5.1.
  - Current account balance (percent of GDP, 2012–2019): -2.8, -2.4, -2.4, -2.6, -2.8, -2.8, -2.8, -2.7.
  - Federal government revenue (percent of GDP, 2013–2024): 16.7, 17.4, 17.9, 18.0, 17.8, 17.7, 17.6, 17.7, 17.7, 17.8, 17.9, 18.0.
  - Federal government expenditure (percent of GDP, 2013–2024): 21.2, 20.9, 21.0, 21.2, 21.0, 20.8, 21.1, 21.3, 21.6, 22.2, 22.2, 22.2.
  - Federal debt held by the public (percent of GDP, 2013–2024): 72.0, 74.2, 74.5, 74.6, 74.5, 74.4, 74.7, 75.4, 76.6, 78.1, 79.7, 81.0.
  - General government gross debt (percent of GDP, 2013–2023): 104.0, 105.8, 106.0, 106.0, 106.0, 106.2, 106.8, 107.9, 109.2, 110.7 (selected years noted).

### Risk Assessment Matrix — selected risks and quantified impacts
- Faster increase in interest rates:
  - Concern: Medium; Likelihood: Medium.
  - Quantified impact: A 50 bps permanent increase in 10-year interest rates could subtract about ½ percent of GDP after two years.
- Distortions from protracted low interest rates:
  - Concern: Low; Likelihood: High.
  - Expected impact: If unaddressed, distortions could lead to financial instability with significant costs and large spillovers.
- Recovery in private investment:
  - Concern: Medium; Likelihood: Medium.
  - Quantified impact: A 5 percentage point increase in private investment growth would add about ¾ percentage points to GDP growth.
- Labor market recovery:
  - Concern: Medium; Likelihood: Medium.
  - Quantified impact: Employment growth of around 1½ percent would be consistent with GDP growth ¼ percentage point higher than the baseline.
- Protracted slower global growth:
  - Concern: High; Likelihood: Medium.
  - Quantified impact: Could subtract about ½ percent of GDP after two years.
- Geopolitical tensions (Russia/Ukraine or Middle East):
  - Concern: Medium; Likelihood: Low.
  - Quantified impact: A sustained 15 percent increase in oil prices above baseline would subtract about 0.2 percent of GDP after two years.
- Failure to pass budget and raise debt limit in 2015:
  - Concern: Low; Likelihood: High.
  - Expected impact: Potentially catastrophic depending on duration, with severe global spillovers.
- U.S. bond market stress:
  - Concern: Low; Likelihood: High.
  - Quantified impact: A 200 bps increase in benchmark Treasury yields would subtract 2.5 and 1.5 percentage points from U.S. growth in 2015 and 2016, respectively.

### Public debt sustainability — baseline and stress findings
- Background: About $2.8 trillion in medium-term fiscal consolidation measures were legislated in 2011–13.
  - Budget Control Act (August 2011): saved about $900 billion over 10 years relative to CBO baseline.
  - Additional savings of $1.2 trillion over 10 years triggered by sequestration and subsequent adjustments.
  - American Taxpayer Relief Act (January 2013): raised $700 billion over 10 years relative to CBO alternative baseline.
- Baseline assessment:
  - General government gross debt projected to briefly stabilize in 2015–18 at about 106 percent of GDP before rising again.
  - Federal debt held by the public projected to increase from 72 percent of GDP now to 81 percent of GDP in FY2024.
  - Debt servicing: average interest rate projected to rise and reach about 5¼ percent by 2023.
  - Policy implication: aim for a medium-term primary surplus of about 1¼ percent of GDP to put public debt ratio on a downward path.
- Stress sensitivities:
  - A 200 basis point increase in the sovereign risk premium would raise the debt ratio about 17 percentage points above baseline.
  - If real GDP growth is one standard deviation below baseline, public debt would reach 122 percent of GDP in 2023.
  - A 1 percentage point slippage in planned consolidation over next two years would lead to gross debt-to-GDP ratio of 116 percent in 2023.
  - A combined macro-fiscal shock could raise public debt ratio to as high as 137 percent of GDP by end of the 10-year horizon.
- Mitigating factor: depth and liquidity of U.S. Treasury market and U.S. safe-haven status mitigate large external financing risks.

### Annex highlights and projections (selected numeric series)
- Baseline projections (annual values cited):
  - Real GDP growth (2012–2023 table): 2012 = 1.7; 2013 = 2.8; 2014 = 1.9; 2015 = 1.7; 2016 = 3.0; 2017 = 3.0; 2018 = 2.9; 2019 = 2.8; 2020 = 2.6; 2021 = 2.3; 2022 = 2.1; 2023 = 2.1.
  - Nominal gross public debt (selected series): 2012 = 74.4; 2013 = 102.4; 2014 = 104.5; 2015 = 105.8; 2016 = 106.0; 2017 = 106.0; 2018 = 106.0; 2019 = 106.0; 2020 = 106.2; 2021 = 106.8; 2022 = 107.9; 2023 = 109.2.
  - Public gross financing needs (percent of GDP, selected): 2012 = 18.2; 2013 = 26.2; 2014 = 24.2; 2015 = 24.1; 2016 = 25.6; 2017 = 25.6; 2018 = 23.4; 2019 = 22.2; 2020 = 21.2; 2021 = 20.2; 2022 = 19.7; 2023 = 19.5; 2024 = 20.6.
  - Effective interest rate (selected): 2012 = 5.6; 2013 = 4.1; 2014 = 3.8; 2015 = 1.4; 2016 = 1.6; 2017 = 2.2; 2018 = 3.0; 2019 = 3.5; 2020 = 4.0; 2021 = 4.5; 2022 = 5.0; 2023 = 5.6; 2024 = 5.9.
- External stability (Annex IV):
  - NIIP declined from -15 percent of GDP in 2010 to -27 percent of GDP in 2013.
  - Under staff baseline, NIIP projected to deteriorate by about 5 percentage points of GDP over next five years.
  - Current account deficit narrowed from about 6 percent of GDP pre-crisis to 2.3 percent of GDP in 2013; projected to widen to about 2¾ percent of GDP by 2019.
  - REER assessment range: broadly in line with fundamentals with a range of -5 percent to +10 percent.

*Source: IMF staff report excerpt from _cr14221.*

### 1. How Reversible is the Decline in U.S. Labor Force Participation? _______________________________ 7

### 1. How Reversible is the Decline in U.S. Labor Force Participation?

### Key recent indicators and context
- The labor force participation rate (LFPR) fell by around 3 percentage points since 2008 and remains below earlier peaks.
- LFPR at June stood at 62.8 percent (its lowest level since 1978).
- LFPR reached an all-time high of 67.3 percent in 2000; a secular decline began after the 2001 recession and accelerated after the global financial crisis.
- The combination of decent job growth and declining participation contributed to a rapid fall in the unemployment rate (reaching 6.1 percent in June).

### Drivers of the LFPR decline (staff analysis)
- Structural and cyclical factors jointly explain the decline:
  - Demographics (population aging and delayed retirement): staff’s demographic models suggest aging explains around 50 percent of the LFPR decline since 2007.
  - Cyclical factors (largely related to job availability): state-level panel regressions suggest the cyclical effect accounts for a further 30–40 percent of the decline.
- Other contributing factors:
  - Youth participation: the decline in youth participation has been driven not by an increase in college enrollment but by a decline in the number of students that are working (from 43 to 37 percent since 2007).
  - Disability insurance: applications rose following the recession; acceptance rates have fallen, but disability dynamics still impact LFPR because applicants—even when denied—are likely to exit the labor force while their application is pending, and the share of the population receiving disability insurance has risen due to aging.

### Reversibility and outlook
- Overall staff analysis suggests that up to one-third of the post-2007 decline is reversible.
- Expected timing:
  - Over the next 2–3 years, a temporary respite in the secular decline of the LFPR is expected as cyclical conditions improve and some reversal occurs.
  - After this interim period, participation rates are expected to start declining again as population aging begins to dominate.
- Implication for the labor market: the projected partial reversal will support growth in the near term, while longer-run demographic forces imply continued downward pressure on participation.

### Related macroeconomic implications (from the broader chapter)
- A steadily improving labor market underpins the baseline growth projection (growth projected in the 3–3½ percent range later in the year), with about one-third of the post-recession decline in the participation rate expected to be reversed.
- A broad measure of the “employment gap” indicates significant labor market slack that will take 3–4 years to be exhausted, consistent with the expectation of only a partial and temporary rebound in participation.
- Real wages are expected to slowly rise alongside steady employment growth as participation partially recovers.

*Source: IMF staff “Box 1. How Reversible is the Decline in U.S. Labor Force Participation?” (from the IMF United States country chapter).*

### 11.      What could go wrong domestically? There continue to be important uncertainties

### 11.      What could go wrong domestically? There continue to be important uncertainties

### Domestic risks to the baseline
- Baseline growth forecast subject to important uncertainties, including the possibility that the slowdown earlier in the year proves more permanent.
- Interest rates could rise more rapidly due to:
  - an unanticipated shift in the Fed’s position, or
  - markets unwinding the recent compression in volatility, term premia, and credit spreads.
- A rapid rise in rates could instigate bouts of financial volatility with damaging implications for U.S. growth.
- Conversely, a continuation of low interest rates could foster a build-up of greater systemic financial stability risks.
- Return of fiscal uncertainties in 2015 (for example, linked to renewed disagreement on the debt limit or the budget) would create downside risks.
- Over a longer horizon, delaying a credible medium-term fiscal consolidation plan could precipitate a loss of confidence and an increase in the sovereign risk premium.

### Global spillovers from U.S. developments
- Given the size and importance of the U.S. economy, realization of the domestic risks above would have significant global implications.
- A one percentage point increase in the U.S. term premium could reduce growth in the rest of the world by around 0.2 percent.
- Low-probability but high-impact risk of U.S. bond market distress could generate a peak world output loss of 3.4–6.0 percent.

### External risks to the U.S. recovery
- Principal external risk: a more pronounced synchronized slowdown in emerging market economies (including China).
  - A one percentage point fall in emerging market growth could lower U.S. growth by 0.1 percent over a year.
- Geopolitical tensions (e.g., Ukraine or Iraq) that lead to financial and trade disruptions, higher commodity prices, and safe-haven capital flows could cause the U.S. dollar to appreciate and U.S. growth to fall by up to 0.2–0.8 percent in 2014–15, depending on severity and longevity.

### Upside scenarios
- Non-residential private investment recovery could be stronger than staff models conservatively predict as confidence grows.
- A more energetic rebound in the participation rate than currently envisaged would raise labor incomes and add to consumer demand.
- Rebuilding of inventories after large first-quarter destocking may provide upside to 2014 growth.
- Overall, distribution of risks around the baseline is believed to be broadly balanced for 2014–15.

### Authorities’ assessment
- Authorities viewed weak first-quarter growth as a temporary aberration, partly weather-related, expecting 2014 growth somewhat below their most recent public forecasts but seeing scope for upside surprises.
- Authorities shared staff’s view of principal risks but saw downside domestic risks as relatively remote; they were more concerned about risks accompanying the recent decline in market pricing of volatility.
- They noted concerns on Europe’s nascent recovery and weaker emerging market growth, particularly risks from China.
- Authorities envisaged a slow rise of inflation to the Fed’s 2 percent objective and a gradual increase in long-term interest rates to around 5 percent over the medium-term.

### Confronting poverty: scope and policy options
- Almost 50 million Americans were living in poverty in 2012 (Census Bureau supplemental poverty measure).
- Official poverty rate has been stuck at about 15 percent since the recession despite recovery in average incomes and employment to above 2007 levels.
- Reducing poverty requires sustained improvement in the economy and employment plus policy efforts to raise real wages at the bottom and provide greater fiscal transfers to the poorest.

Policy measures to support the poor (as discussed)
- Expand the Earned Income Tax Credit (EITC) for:
  - workers without dependents,
  - low-income youth,
  - older workers not yet eligible for social security.
- Make permanent the 2009 extensions (EITC to larger families, mitigation of the “marriage penalty”, increase and refundability of the Child Tax Credit) that are due to expire in 2017.
- Complement EITC expansion with an increase in the federal minimum wage to ensure firms bear part of the cost and to avoid EITC simply lowering pre-tax wages.
- President’s 2015 Budget proposals highlighted:
  - doubling the childless worker EITC,
  - making younger adult workers eligible for the EITC,
  - requiring federal contractors to pay at least $10.10 per hour and calling on Congress to raise the minimum wage to $10.10 for all workers.
- As of June 1, 2014, 22 states and the District of Columbia have minimum wages above the federal minimum.

Box 3 summary (EITC and minimum wage complementarities and fiscal costs)
- Combination of making permanent EITC extensions, doubling childless worker EITC and expanding to ages 21–24, and raising the federal minimum wage from $7.25 to $10.10 evaluated.
- Estimated fiscal costs and impacts (selected figures from staff calculations and sources cited):
  - Make permanent 2009 EITC/CTC extensions: 97.4 billion ($ over 10 years); 0.04 percent of GDP; Increase of about 40 percent of average after-tax income for poor households; Reduction in official poverty rate: 6.8–0.5 percentage points (table formatting in source).
  - Double maximum EITC for individuals without dependents and expand to ages 21–24: 59.7 billion; 0.03 percent of GDP; Increase of about 20 percent of average after-tax income; Reduction in official poverty rate: 4.4–0.4 percentage points.
  - Raise federal minimum wage from $7.25 to $10.10: Decrease of about 500 (thousands) in employment effect; Fiscal cost negligible in table; 2.6–0.3 percent of average after-tax income; Reduction in official poverty rate: figures in table.
  - Combination of all measures: 146.9 billion; 0.06 percent of GDP; Decrease of about 400 (thousands); Increase in take-home pay for poor households of 9.7–1.0 percent of average after-tax income.
- In 2012, there were 3.6 million hourly paid workers with wages at or below the federal minimum wage of $7.25 per hour; a further 13 million earn below $10 per hour. Slightly more than half of these workers were in the leisure and hospitality industry.
- The minimum wage in the U.S. is 37.8 percent of the median wage; OECD average is 47.1 percent of the median wage.

### Countering the decline in potential growth: pressures and policy priorities
Key pressures on potential growth
- Potential growth expected to level off at around 2 percent in the coming years, below the pre-crisis average of over 3 percent.
- Main drags:
  - Slower labor force expansion given population aging:
    - Labor force expected to expand at a slow pace (of below ½ percent per year), half the average growth rate seen in 2000–13 and well below the average (1.2 percent) growth seen over the past 30 years.
  - A slowdown in productivity:
    - Labor productivity hit a step-down attributed to smaller contributions from capital deepening and total factor productivity linked to IT.
    - Staff forecast assumes a partial rebound in labor productivity (non-farm business sector output per hour worked) from 0.5 percent in 2013 to around 1.6 percent by the end of the decade, compared with average 2¾ percent gains between 1998 and 2007.
- It is currently impossible to distinguish whether recent productivity decline is long-lasting or will be partly reversed by new innovations and energy-related productivity effects.

Policy priorities to boost potential growth
- Galvanize infrastructure investment:
  - Government capital stock ratio has resumed a downward trend since the 1980s; additional investment urgently required, particularly for surface transportation.
  - American Society of Civil Engineers estimates $200 billion (about 1.1 percent of GDP) in funding is necessary to meet U.S. infrastructure investment needs from 2014 to 2020.
  - Provide clarity on financing of the Highway Trust Fund as a near-term priority; sustain increased federal and state infrastructure spending paid for by savings in future entitlement outlays, additional revenues, and expanded financing sources (including innovations such as the America Fast Forward Bonds).
  - Under America Fast Forward Bonds: federal subsidy payments would equal 28 percent of interest costs on bonds used to finance infrastructure projects and 50 percent if bonds are issued in 2014 and 2015 to finance building of schools.
- Tax reform:
  - Comprehensive tax reform (broadening bases, simplification, reduction of statutory tax rates for individual and corporate income tax) could raise real GDP by up to 1.6 percent over the next ten years.
  - Broaden individual income tax base by reducing exemptions and deductions; cap or eliminate itemized deductions including the mortgage interest deduction over time.
  - On corporate side, broaden base, lower marginal corporate tax rate, and change tax treatment of multinationals to limit base erosion and profit shifting.
- Incentivize innovation and build skills:
  - Reinstate and make permanent the Research and Experimentation (R&E) tax credit (expired December 2013).
  - Improve state-level training programs, partnerships for apprenticeships and vocational training, and government-provided job search assistance.
  - Prioritize early childhood education (including universal pre-K) and support for STEM programs.
- Boost labor supply and reduce long-term unemployment:
  - Expand EITC and improve family benefits (including childcare assistance) to reverse downward trend in female labor force participation.
  - Modify disability insurance to provide incentives for beneficiaries to work part-time.
  - Reach agreement on immigration reform to attract high-skilled workers and boost productivity.
  - Time-bound tax credits or wage subsidies to employers hiring the long-term unemployed.

*Source: _cr14221 — IMF staff report excerpt.*

### Box 4. Productivity Growth and Its Determinants: Evidence from the U.S. States

### Box 4. Productivity Growth and Its Determinants: Evidence from the U.S. States

### Overview
- Aggregate total factor productivity (TFP) growth slowed in the mid 2000s, well before the financial crisis.
- Debate: some argue the IT revolution had run its course; others maintain the IT revolution could continue to boost U.S. TFP growth.

### State-level TFP evidence
- Change in TFP growth over 2005–10 (relative to 1996–2004) varied markedly across states:
  - Over 3 percentage points in New Mexico and South Dakota.
  - Below 1 percentage point in states like Washington, Oregon, Nebraska, Maryland, and others.
- Little evidence that the TFP slowdown was stronger in states that were either specialized in IT production or that used IT more intensively.

### Decomposition of TFP dynamics
- Staff uses a stochastic frontier analysis to decompose TFP dynamics into:
  - Technological progress: shifts the production frontier upward for all states.
  - Improvement in technical efficiency: moves each state closer to the production frontier.
- Empirical observation: large variation in the efficiency of production across U.S. states.

### Determinants of efficiency
- States with the following characteristics tend to be more efficient and closer to the technological frontier:
  - Better human capital (education).
  - Higher spending on research and development (R&D).
  - A more developed financial system (concentration of financial services).

### Panel regression findings
- Panel regressions of TFP growth across U.S. states over the last two decades corroborate the stochastic frontier results:
  - Higher educational attainment is linked to higher TFP growth.
  - Greater spending on R&D, especially by the government, is linked to higher TFP growth.

*Source: Box 4. Productivity Growth and Its Determinants: Evidence from the U.S. States (IMF staff).*

### 32.      Global spillovers. The impending increases in U.S. interest rates will have important

### _cr14221 - 32.      Global spillovers. The impending increases in U.S. interest rates will have important

### Global spillovers
- If increases in U.S. interest rates come at a time of higher U.S. equity prices and a better U.S. growth outlook, they should generally be a positive factor for other countries, though "pockets of stress" may persist in more vulnerable economies.
- An increase in the long rate not accompanied by a U.S. growth improvement (for example, a shift in Fed policy driven by concerns about a pickup in inflation) will have an unambiguously negative outward spillover effect, especially for those emerging markets (EMs) and advanced economies with already-weak fundamentals (as was seen in 2013). This would likely mean:
  - higher sovereign and corporate spreads,
  - a slowdown or reversal of capital flows,
  - lower asset prices, and
  - a drag on EM growth.
- Model estimates indicate that second-round effects (multiplier effect of a movement in U.S. rates, spilling out to EMs and other advanced economies, and then feeding back into U.S. growth and inflation) are likely to be empirically modest.
- Larger feedback effects not easily captured by models remain possible (for example, a tail event where U.S. policy action triggers crises in several vulnerable countries), but any estimate of their size would be necessarily speculative.

### Authorities’ views (monetary policy and spillovers)
- Monetary policy would adapt to changing economic circumstances and be focused on achieving the Fed’s mandate of maximum employment and price stability.
- The authorities believed the recent increase in core PCE inflation mainly reflected "transitory or seasonal factors" and emphasized that inflation is unlikely to return to 2 percent until wage growth moves above labor productivity growth.
- If inflation were to rise close to their longer-term goal but the economy appeared to remain well below full employment, authorities would carefully re-examine the assessment of the degree of slack left in the economy.
- Authorities stated they would not try intentionally to overshoot the inflation target; if inflation rose above 2 percent the pace at which they would try to subsequently disinflate would depend on how much progress had been made in achieving the employment mandate.
- Authorities recognized international implications of U.S. monetary policy; Fed staff had undertaken significant analysis to better understand outward spillovers. They would not discount the potential risks of second-round effects, but highlighted uncertainty surrounding the size of both spillovers and subsequent "spillbacks".

### Communication (Fed forward guidance and recommendations)
- The Fed has increased transparency and adopted an adaptable approach to communication; forward guidance has generally been effective in managing expectations and reducing uncertainty about future policy rates (see Box 5).
- The return to qualitative forward guidance in March provides greater flexibility but increases the premium on clear and systematic communication to guide expectations, given potential adverse effects of miscommunication for international financial markets.
- Enhancing the Fed’s communications toolkit could help temper market volatility or abrupt asset price corrections along the exit path.
- Specific considerations for communication enhancements:
  - Scheduling press conferences by the Fed Chair after each FOMC meeting to provide a more frequent, structured environment to explain the committee’s evolving thinking.
  - Publishing a quarterly monetary policy report, endorsed by the FOMC, conveying more detail about the majority view of the FOMC on the outlook, policies, and uncertainties around the baseline; such a report may also convey dissenting views and broader information on FOMC policy reactions in plausible, non-baseline scenarios. This would complement the "dots" and provide a more systematic way to convey the majority FOMC view.
  - Providing greater clarity from the FOMC on how it views current conditions for financial stability, how such considerations figure into monetary policy decisions (both about the balance sheet and policy interest rates), and how these relate to its current mandate. This would allow the Fed to convey how monetary policy may be affected by assessments of declines in realized and expected volatility, build-ups in leverage, credit risks, unsustainable declines in term premia, or other financial stability concerns.

### Authorities’ views (on communication and financial stability)
- Attempts had been made in the past to agree on some form of monetary policy report but reaching agreement among FOMC members on the structure and on forecasts or scenarios proved very difficult.
- The authorities would continue to examine such possibilities and emphasized the inappropriateness of viewing the median of the summary of economic projections as a representation of the aggregate views of the FOMC.
- Quarterly press conferences currently coincide with the publication of the summary of economic projections; authorities felt tangible benefits from more frequent press conferences were unclear at this stage.
- Taking account of financial stability concerns is complex because there is no solid analytical structure yet to frame such issues in the context of monetary policy, though the FOMC is "highly attuned to financial developments" and does take readings on financial developments into account.

### Operational issues (exit, balance sheet, and market operations)
- Barring unforeseen developments, the current pace of tapering should be maintained, implying an end to asset purchases in late 2014.
- Normalization of the Fed’s balance sheet over the medium term should occur by letting asset holdings mature (in line with the June 2011 "exit principles" and subsequent communications).
- It would be useful for the Fed to provide greater clarity at an early stage, through a formal update of its exit principles.
- The effectiveness of the fed funds target as the signal for monetary policy may pose a challenge for the operational framework once rates begin to rise. Although the fed funds market is unlikely to operate as it did before the financial crisis, there are arguments for retaining the fed funds target for now while maintaining flexibility to respond to market reactions during exit.
- The use of the overnight reverse repo and interest on excess reserves should allow the Fed to set a solid floor on market rates; this could be complemented with term instruments to absorb excess liquidity.
- The recent expansion in Fed counterparties for the overnight reverse repo potentially creates arbitrage opportunities by encouraging resources to migrate from banks to money market funds that now have access to Fed instruments; these risks could be managed through the setting of rates (on the overnight reverse repo) and caps on either an aggregate or per counterparty basis.
- The FOMC continues to evaluate the appropriate future operational framework for normalizing policy in the context of the Fed’s large balance sheet, including the appropriate role of the fed funds target in communications regarding monetary policy during normalization.
- A new money market survey is likely to help the Fed better understand different segments of the money market.
- The Fed could employ a variety of other short-term rates (such as the interest on excess reserves and the overnight reverse repo rate) in its policy communications during exit.

### Securing a safer financial system — Banking sector progress and vulnerabilities
- Progress:
  - Tier 1 common equity ratio rose to 11.6 percent at end-2013 for the largest U.S. banks.
  - The recent Fed stress tests showed the 30 largest U.S. banks are resilient to a severe deterioration of domestic macroeconomic conditions.
  - The majority of the large U.S. banks will add capital over the next two years.
- Stress-test outcomes and vulnerabilities:
  - In the latest CCAR stress tests, capital plans were rejected for five banks (including three foreign-owned bank holding companies), of which four were rejected based on qualitative concerns about their internal controls.
  - Stress tests showed that, if hit by a severe global market shock, larger U.S. banks would face a significant decline in their capital ratios and sizable losses from trading activities.
  - For investment banks, a non-trivial dependence on wholesale funding remains a source of vulnerability in periods of severe financial market distress.
- Regulatory changes have lowered systemic risks but may weigh on banks’ future profitability; current return on equity remains well below pre-crisis averages.
- There is a risk banks may try to restore profitability through looser lending standards or lengthening the duration of assets, increasing asset-liability mismatches; avoiding this will necessitate intensive bank supervision.

### Insurance sector risks and recommendations
- Risks:
  - Possible risks building due to a search for yield in a prolonged low interest rate environment; investment returns have been steadily falling, narrowing the gap with required returns on portfolios.
  - Concerns about ceding of liabilities to affiliated and less-regulated off-balance sheet reinsurance vehicles.
  - Oversight of the insurance sector is fragmented between state and federal entities; lack of timely and publicly-available consolidated data (including offshore activities) complicates monitoring of credit and liquidity risks.
- Recommendations:
  - Assess and publicize such risks through a coordinated, nationally consistent approach to supervision and stress testing.
  - The Federal Insurance Office should have a significantly larger role in the regulatory framework and be resourced accordingly.

### Mortgage availability and housing finance
- Mortgage availability:
  - Tighter regulatory regime for mortgage lending has better matched costs with risks but has held back housing market recovery through a conservative approach to mortgage lending, particularly to lower-rated borrowers.
  - Drivers include persistent anxiety about potential "put-back" risks, litigation and reputational risks to lenders, tighter regulation and supervisory scrutiny, and uncertainty about the future structure of the mortgage industry.
  - Steps taken include establishing a safe harbor for Qualified Mortgages and clarifying conditions for put-backs.
  - There is scope to lessen uncertainties facing lenders without undermining regulatory and supervisory scrutiny, including improving information sharing during mortgage origination and clarifying the scope of exemptions in "sunset" clauses.
- Housing finance system objectives going forward:
  - A more clearly-defined and transparent government participation, with transparent fiscal accounting of public interventions linked to social housing goals.
  - The eventual system should have:
    - A substantial first-loss risk borne by private capital (rather than taxpayers);
    - An explicit public backstop limited to catastrophic credit losses with risk-based guarantee fees;
    - A role for regulatory agencies in setting underwriting standards; and
    - A common platform for securitization.
  - The transition should be carefully phased to avoid undermining housing market recovery and the tentative restart in the private securitization market, while maintaining appropriate underwriting standards and supervision to discourage future overinvestment and unsustainable leverage.

### Corporate credit market risks
- Ample liquidity and low rates have encouraged companies to refinance, extend maturities, and push rollover risks into the future.
- Indications of rising underwriting and leverage risks:
  - Gross issuance of high yield bonds and loans in 2011–13 is more than double that in 2005–07.
  - The share of bonds being issued with non-cash coupons or CCC ratings, and of loans that are covenant-lite or with second-liens, is rising.
  - Debt-to-earning levels for corporations taking on highly leveraged loans are increasing.
- While lower credit costs and longer maturities should lessen the likelihood of corporate stress, as the credit cycle matures increased exposure to riskier borrowers and aggregate rise in leverage in the nonfinancial corporate sector could contribute to a rising rate of default and lower recoveries on defaulted debt.

*IMF staff summary from the referenced chapter.*

### 44.      Nonbank intermediary risks. Intermediation

### 44. Nonbank intermediary risks. Intermediation

### Key vulnerabilities and potential scenarios
- Growth of intermediation outside the banking system is producing a range of potential risks highlighted in the 2014 FSOC Annual Report, including:
  - The growing amount of maturity and liquidity transformation through mutual funds or exchange-traded funds (ETFs), particularly those investing in credit instruments.
  - The volume of nonbank flows being directed to higher credit risk and longer duration assets.
  - The uncertain leverage and risks embedded in securities lending undertaken by large financial institutions.
  - A decline in broker-dealer involvement in market making activity, potentially hampering market functioning and price discovery at times of market stress.
- Potential disruptive scenario:
  - An abrupt unwinding of compressed market pricing of volatility and risk and term premia or an upcoming rise in short-term interest rates could trigger a tail risk.
  - A precipitous attempt by investors to exit certain markets—potentially exacerbated by outflows from ETFs and mutual funds and near-term market illiquidity—could trigger a sudden, self-reinforcing re-pricing of a range of financial assets.
  - Resulting impacts could include sharp losses for nonbanks, negative wealth effects lowering U.S. growth, difficulties in rolling over or accessing new financing, corporate-sector strains, and negative international knock-on effects.
- Overall assessment:
  - Despite these pockets of vulnerability, overall financial stability risks appear to have marginally declined over the past year.
  - The banking system would be robust to such a set of events, but nonbanks would be more dramatically affected.

### Regulatory responses and policy options
- Progress to date:
  - Finalization of the Volcker rule, designation of another systemically important financial institution, implementation of OTC derivative reform, and introduction of liquidity and leverage requirements compatible with Basel III standards.
  - A rule requiring certain foreign bank organizations (FBOs) to incorporate as holding companies was introduced (see Box 6).
- Supervisory and prudential measures that could be tightened:
  - Tighten underwriting standards for riskier commercial lending.
  - Attach higher risk weights or tighter limits on large exposures for particular assets (such as leveraged loans or high yield bonds).
  - Strengthen prudential norms for holdings of securitized loans such as collateralized loan obligations (CLOs) by regulated entities.
  - Impose additional capital charges on insurance companies.
- Specific steps for structural vulnerabilities:
  - Money market mutual funds:
    - Introduce floating net asset value rules for prime money market mutual funds to mitigate run risk; such rules should be introduced for those funds which invest in government securities.
    - Alternatives include imposing stricter liquidity requirements or investment restrictions. These options are being considered by the SEC and may result in a new rule.
  - Tri-party repo markets:
    - Impose stricter haircuts and margins to limit the risk of a pre-default sale of repo collateral (noting the U.S. already imposes higher haircuts than the Financial Stability Board minimum).
    - Develop mechanisms to counter ‘fire sale’ dynamics in the tri-party repo market.
  - Too-important-to-fail and resolution:
    - Continue to build on Dodd-Frank Act provisions for orderly resolution of systemically important financial institutions.
    - Finalize remaining rules to fully implement the orderly liquidation authority for systemic nonbanks.
    - Thoroughly assess resolution and recovery plans against severe contingencies with large cross-border components.
    - Progress cooperative arrangements with regulators in other jurisdictions, building on joint crisis-planning exercises and the Key Attributes of Effective Resolution Regimes.
    - Consider formal designation of large, interconnected, and complex institutions as systemically important in the insurance and asset management sectors.
  - Strengthening the macro-prudential framework:
    - Improve data and analysis sharing among regulatory agencies and the Office of Financial Research.
    - Clarify how Office of Financial Research monitoring translates into FSOC recommendations.
    - Institute a timely and structured process for regulatory agencies to respond to FSOC recommendations.

### Box 6 — The Foreign Bank Organizations (FBO) Rule (key facts)
- By July 1, 2016 FBOs with more than $50 billion assets in U.S. bank and nonbank subsidiaries will be required to reorganize U.S. operations under an intermediate holding company (IHC).
- The resulting IHC will become subject to a 3 percent Tier 1 leverage ratio and similar prudential liquidity standards as U.S. Bank Holding Companies (BHCs).
- FBOs with assets between $10–50 billion will be subject to enhanced prudential standards.
- Current FBO role in the U.S. financial system:
  - Account for 15 percent of the total U.S. banking assets.
  - Account for approximately 40 percent of the reserves held at the Fed.
  - Account for around one-half of the U.S. corporate bond issuance.
  - Account for one-third of equity trading.
  - Of the 22 primary dealers for the Federal Reserve, 15 are FBOs.
- Potential effects and adjustments:
  - Requiring IHC capitalization improves U.S. financial resilience and aligns governance to U.S. BHC standards; appears consistent with Basel III.
  - May reduce parent-level profitability and induce organizational changes.
  - Likely minor impact on U.S. bank credit (loans and portfolio holdings of FBOs account for less than 10 percent of lending).
  - Potentially larger effects on U.S. capital markets if some FBOs scale down U.S. operations rather than raise equity, possibly lowering liquidity and raising transaction costs.
  - Repo transactions will start to count towards total leverage on a gross basis, which could make some repo lending by FBOs uneconomic (particularly low margin, balance-sheet-intensive repos of Treasuries and Agency MBS).
- Estimated capital shortfall (limited public data, year-end 2013):
  - Of 14 FBOs likely required to form IHCs, 4 currently fail to meet the 3 percent Tier 1 leverage ratio.
  - Assuming zero retained earnings or asset sales between now and July 1, 2016, the total capital shortfall to meet the Tier 1 leverage ratio would be about $17.4 billion (estimate tentative).

### Global spillovers and financial integrity
- Global spillovers:
  - Recent U.S. regulatory changes—including the Volcker rule and the FBO rule—will lower financial stability risks and reduce negative spillovers from the U.S.
  - These changes may increase capital costs for market-making and trading activities of foreign banks operating in the U.S.
  - At this stage, little evidence that U.S. regulatory changes are adding to financial fragmentation or balkanizing the global financial system; further examination planned in the upcoming FSAP.
- Financial integrity:
  - Initiatives are underway to strengthen beneficial ownership identification and verification and access to information about beneficial ownership and control of U.S. corporations.
  - These initiatives aim to address deficiencies from the June 2006 FATF mutual evaluation report.
  - Implementation may occur only after 2015 and would imply only a modest improvement in transparency of U.S. corporations and trusts.
  - It will remain difficult to pursue laundering of proceeds of foreign tax crimes taking place inside the U.S. or the use of U.S. corporations to commit tax crimes abroad.

### Authorities’ views and staff appraisal on financial stability and related policy
- Authorities’ views:
  - Substantial progress was reported in regulatory framework improvements, increased capital and liquidity buffers, and reduced leverage.
  - FSOC process viewed as working well.
  - Low interest rates could create potential financial stability risks but currently are not viewed as systemic and are concentrated in pockets of vulnerabilities.
  - Concerns include low levels of market pricing of volatility and embedded risks in securities lending and the repo market.
  - Authorities expected the SEC to soon issue rules to tackle risks in money market mutual funds and are working to understand risks in asset management and modernize insurance regulation.
  - Commitment to the G20 financial reform agenda and leadership in international derivatives regulation and leverage ratio agreements was emphasized.
- Staff appraisal — financial stability and macro policy linkages:
  - Much has been done to reduce financial system risks: banks stronger, corporate balance sheets healthy, leverage contained, regulatory framework improved.
  - Prolonged very low interest rates continue to raise concerns, particularly in shadow banks and nonbank intermediaries.
  - Recommended steps to tackle remaining risks:
    - Tighter underwriting standards.
    - Higher risk weights.
    - Tighter limits on large exposures to riskier assets.
    - Stronger prudential norms for holdings of securitized loans by regulated entities.
    - Address money market funds and tri-party repo vulnerabilities.
    - Continue implementing measures for orderly resolution of too-important-to-fail institutions and deepen cross-border cooperation.
    - Insurance sector: stronger and more uniform capital adequacy and solvency oversight, harmonized stress testing, close data gaps, further designation of systemically important firms, and a larger federal role in insurance regulation and oversight.
  - The U.S. should continue to lead in advancing global regulatory reform, ensure consistency with international rules and best practices, and limit opportunities for regulatory arbitrage while monitoring spillover implications.

### Selected macroeconomic and labor projections and implications (from staff appraisal)
- Growth:
  - GDP projected to expand at 1.7 percent for 2014 as a whole.
  - Growth expected to rise to 3 percent in 2015 (annual basis).
- Labor market:
  - Economy expected to reach full employment only by end-2017.
  - Headline unemployment expected to decline only slowly; long-term unemployment and involuntary part-time work remain high; labor force participation remains below what demographic factors explain.
- Monetary policy considerations:
  - Policy rates could remain at zero longer than the mid-2015 date currently foreseen by markets if the economy reaches full employment only by end-2017 and inflationary pressures remain muted.
  - If inflation rose more rapidly while the economy remained below full employment, tolerating a modest temporary rise of inflation above the longer-term goal could be consistent with the Fed’s balanced approach, conditional on anchored inflation expectations and low financial stability risks.
  - Well-communicated normalization of U.S. monetary conditions, in the context of robust U.S. growth, would be positive globally.
- Fiscal policy:
  - Recent Bipartisan Budget Act (December 2013) and raising of the debt ceiling improved near-term deficit reduction; further targeted near-term measures (e.g., front-loaded infrastructure spending, tax system improvements, active labor market policies, educational spending) are recommended, funded by offsetting savings in future years.
  - Longer-term fiscal sustainability requires a credible medium-term consolidation plan, measures to lower health care spending, restore Social Security solvency, tax reform, and revenue measures.
  - Changes to budget procedures—such as switching to a two-year budget cycle—could lessen fiscal policy uncertainty.

*Source: IMF staff analysis in “UNITED STATES” country report section 44–57.*

### 58.      Housing finance. Limited availability of mortgage financing is a pressing constraint on

### _cr14221 - 58.      Housing finance. Limited availability of mortgage financing is a pressing constraint on

### Housing finance: constraints, policy options, and recommended administrative steps
- Key constraint: Limited availability of mortgage financing is a pressing constraint on economic growth.
- Outlook for mortgage lending: The recovery of mortgage lending to lower-rated borrowers is likely to be a slow process.
- Legislative clarity: Legislative changes that clarify the future role of government in housing finance would help.
- Administrative actions (can realize many objectives in the medium term while broader legislation is pending):
  - Expand the use of market transactions to transfer first-loss risks from the agencies to private investors.
  - Move gradually to higher and more risk-based guarantee fees.
  - Steadily build up capital within the agencies while reducing their role in housing finance.
  - Establish a single securitization platform.

### Consultation timing recommendation
- It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

### Selected macroeconomic projections and key statistics (staff projections and indicators)
- Real GDP: 2.8, 1.9, 1.7, 3.0, 3.0, 2.9, 2.8, 2.6 (for 2012–2019, percentage change from previous period)
- Unemployment rate: 8.1, 7.4, 6.4, 6.0, 5.8, 5.6, 5.5, 5.5 (2012–2019)
- CPI inflation: 2.1, 1.5, 1.8, 1.8, 1.9, 2.0, 2.0, 2.0 (2012–2019)
- Ten-year government bond rate: 1.8, 2.4, 2.7, 3.3, 4.0, 4.5, 5.0, 5.1 (2012–2019)
- Current account balance (percent of GDP): -2.8, -2.4, -2.4, -2.6, -2.8, -2.8, -2.8, -2.7 (2012–2019)
- Federal government revenue (percent of GDP): 16.7, 17.4, 17.9, 18.0, 17.8, 17.7, 17.6, 17.7, 17.7, 17.8, 17.9, 18.0 (2013–2024)
- Federal government expenditure (percent of GDP): 21.2, 20.9, 21.0, 21.2, 21.0, 20.8, 21.1, 21.3, 21.6, 22.2, 22.2, 22.2 (2013–2024)
- Federal debt held by the public: 72.0, 74.2, 74.5, 74.6, 74.5, 74.4, 74.7, 75.4, 76.6, 78.1, 79.7, 81.0 (2013–2024, percent of GDP)
- General government gross debt: 104.0, 105.8, 106.0, 106.0, 106.0, 106.0, 106.2, 106.8, 107.9, 109.2, 110.7 (2013–2023, percent of GDP)

### Risk Assessment Matrix: selected risks, likelihoods, and quantified impacts
- Faster increase in interest rates
  - Overall level of concern: Medium
  - Likelihood of realization: Medium
  - Quantified impact: A 50 bps permanent increase in 10-year interest rates could subtract about ½ percent of GDP after two years.
- Distortions from a protracted period of low interest rates
  - Overall level of concern: Low
  - Likelihood of realization: High
  - Expected impact: If unaddressed, distortions could lead to financial instability with significant economic costs and large spillovers to the rest of the world.
- Recovery in private investment
  - Overall level of concern: Medium
  - Likelihood of realization: Medium
  - Quantified impact: A 5 percentage point increase in private investment growth would add about ¾ percentage points to GDP growth.
- Labor market recovery
  - Overall level of concern: Medium
  - Likelihood of realization: Medium
  - Quantified impact: Employment growth of around 1½ percent would be consistent with GDP growth that is ¼ percentage point higher than the baseline.
- Protracted period of slower growth (and lower inflation) in advanced and emerging economies
  - Overall level of concern: High
  - Likelihood of realization: Medium
  - Quantified impact: Slower growth in advanced and emerging economies could subtract about ½ percent of GDP after two years.
- Increasing geopolitical tensions/risks surrounding Russia/Ukraine or the Middle East
  - Overall level of concern: Medium
  - Likelihood of realization: Low
  - Quantified impact: A sustained 15 percent increase in oil prices above baseline would subtract about 0.2 percent of GDP after two years.
- Failure to pass budget and raise debt limit in 2015
  - Overall level of concern: Low
  - Likelihood of realization: High
  - Expected impact: The economic cost would be potentially catastrophic depending on how long the impasse lasts with severe global spillovers.
- U.S. bond market stress
  - Overall level of concern: Low
  - Likelihood of realization: High
  - Quantified impact: A 200bps increase in the benchmark Treasury yields would subtract 2.5 and 1.5 percentage points from U.S. growth in 2015 and 2016, respectively.

### Public Debt Sustainability Analysis: background, baseline, and stress scenarios
- Background: About $2.8 trillion in medium-term fiscal consolidation measures were legislated in 2011–13.
  - Budget Control Act (August 2011): capped discretionary spending, saving about $900 billion over 10 years relative to the CBO baseline.
  - Additional savings of $1.2 trillion over 10 years triggered by failure of the Congressional Committee on Deficit Reduction in November 2011 (sequestration in FY2013 and subsequent adjustments through the Bipartisan Budget Act of December 2013).
  - American Taxpayer Relief Act (January 2013): raised $700 billion over 10 years relative to the CBO alternative baseline.
- Baseline assessment:
  - Under staff’s baseline, general government gross debt is projected to briefly stabilize in 2015–18 at about 106 percent of GDP but starts rising again thereafter.
  - Federal debt held by the public is projected to increase from 72 percent of GDP now to 81 percent of GDP in FY2024.
  - General government gross debt approaches 111 percent of GDP by CY2023.
  - Debt servicing: The average interest rate is projected to rise gradually and reach about 5¼ percent by 2023.
  - Policy implication: Aiming for a medium-term primary surplus of about 1¼ percent of GDP would be appropriate to put the public debt ratio firmly on a downward path; a higher target would be required in the long run to approach pre-crisis debt levels by 2030.
- Stress tests and sensitivity:
  - A 200 basis point increase in the sovereign risk premium would mean a debt ratio about 17 percentage points above the baseline.
  - If real GDP growth is one standard deviation below the baseline, the public debt would reach 122 percent of GDP in 2023.
  - A 1 percentage slippage in the planned consolidation over the next two years would lead to a gross debt-to-GDP ratio of 116 percent in 2023.
  - A combined macro-fiscal shock could raise the public debt ratio as high as 137 percent of GDP by the end of the 10-year horizon.
- Mitigating factor: The depth and liquidity of the U.S. Treasury market and the safe haven status of the United States mitigate risks associated with large external financing requirements.

*Source: IMF staff estimates and analysis as presented in the content unit.*

### Annex Table 1. United States: Public DSA—Risk Assessment

### _cr14221 - Annex Table 1. United States: Public DSA—Risk Assessment

### Risk assessment and heat‑map indicators
- Debt burden benchmarks and heat‑map coloring rules:
  - Debt burden benchmark: 85%.
  - Gross financing needs benchmark: 20% of GDP.
  - Bond spread shocks: 400 and 600 basis points.
  - External financing requirement shocks: 17 and 25 percent of GDP.
  - Change in the share of short‑term debt shocks: 1 and 1.5 percent.
  - Public debt held by non‑residents shocks: 30 and 45 percent of total.
- Indicator highlights (2013 levels reported in table):
  - Bond spread: 119 bp (long‑term bond spread over German bonds, average 03‑Apr‑13 through 02‑Jul‑13).
  - External financing requirement: 12 (in percent of GDP) shown against benchmarks.
  - Annual change in short‑term public debt: 1 (in percent of total) with upper shock 1.5.
  - Public debt held by non‑residents: 32% (in percent of total) with shocks at 30 and 45.
- Distributional and projection notes:
  - Evolution of predictive densities of gross nominal public debt displayed in percent of GDP for percentiles: 10th–25th, 25th–75th, 75th–90th and Baseline.
  - Symmetric and Restricted (Asymmetric) distribution scenarios presented for 2012–2022.
- Stress test shock caps and restrictions:
  - Max positive growth rate shock: 0.5 (percent).
  - Max negative interest rate shock: 1 (percent).
  - No restriction on the primary balance shock.
  - No restriction on the exchange rate shock.
  - Restrictions on upside shocks noted.

### Key methodological definitions (as provided)
- External financing requirement: sum of current account deficit, amortization of medium and long‑term total external debt, and short‑term total external debt at the end of previous period.
- Effective interest rate defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.
- Automatic debt dynamics formula and components given in footnotes (r, π, g, a, e definitions preserved in source).

---

### Annex Table 2 — Realism of baseline assumptions and forecast track record
- Forecast errors (United States median, 2005–2013):
  - Real GDP growth forecast error: -0.74 (in percent, actual–projection); United States has a percentile rank of 20%.
  - Primary balance forecast error: -0.70 (in percent of GDP, actual–projection); United States has a percentile rank of 38%.
  - Inflation (GDP deflator) forecast error: 0.68 (in percent, actual–projection); United States has a percentile rank of 39%.
- Forecast distributions and comparisons:
  - Plotted distributions include all countries; percentile ranks refer to all countries.
  - Projections compared versus WEO spring vintage of the preceding year.
  - Boom‑Bust analysis: “Not applicable for United States” for criteria listed (positive output gap and private credit growth criterion).
- Assessing projected fiscal adjustment:
  - 3‑Year Adjustment in Cyclically‑Adjusted Primary Balance (CAPB) distribution shown (percent of GDP).
  - 3‑Year Average Level of CAPB distribution shown (percent of GDP).

---

### Annex Table 3 — Baseline scenario (As of July 02, 2013)
- Selected baseline projections (annual values where listed):
  - Nominal gross public debt: 2012 = 74.4; 2013 = 102.4; 2014 = 104.5; 2015 = 105.8; 2016 = 106.0; 2017 = 106.0; 2018 = 106.0; 2019 = 106.0; 2020 = 106.2; 2021 = 106.8; 2022 = 107.9; 2023 = 109.2; 2024 = 110.7 (table lists up to 2023 with cumulative change reported).
  - Public gross financing needs: 2012 = 18.2; 2013 = 26.2; 2014 = 24.2; 2015 = 24.1; 2016 = 25.6; 2017 = 25.6; 2018 = 23.4; 2019 = 22.2; 2020 = 21.2; 2021 = 20.2; 2022 = 19.7; 2023 = 19.5; 2024 = 20.6.
  - Real GDP growth (in percent): 2012 = 1.7; 2013 = 2.8; 2014 = 1.9; 2015 = 1.7; 2016 = 3.0; 2017 = 3.0; 2018 = 2.9; 2019 = 2.8; 2020 = 2.6; 2021 = 2.3; 2022 = 2.1; 2023 = 2.1.
  - Inflation (GDP deflator, in percent): 2012 = 2.2; 2013 = 1.7; 2014 = 1.5; 2015 = 1.6; 2016 = 1.8; 2017 = 1.9; 2018 = 2.0; 2019 = 2.0; 2020 = 2.0; 2021 = 2.1; 2022 = 2.0; 2023 = 2.0.
  - Nominal GDP growth (in percent): 2012 = 4.0; 2013 = 4.6; 2014 = 3.4; 2015 = 3.3; 2016 = 4.9; 2017 = 4.9; 2018 = 5.0; 2019 = 4.8; 2020 = 4.7; 2021 = 4.4; 2022 = 4.1; 2023 = 4.1; 2024 = 4.1.
  - Effective interest rate (in percent): 2012 = 5.6; 2013 = 4.1; 2014 = 3.8; 2015 = 1.4; 2016 = 1.6; 2017 = 2.2; 2018 = 3.0; 2019 = 3.5; 2020 = 4.0; 2021 = 4.5; 2022 = 5.0; 2023 = 5.6; 2024 = 5.9.
  - EMBIG (bp) = 134; 5‑year CDS (bp) = 16 (table lists sovereign spreads).
- Contribution to change in gross public sector debt (selected flows, percent of GDP):
  - Change in gross public sector debt cumulative (2012 onward): 4.8; 3.4; 2.2; 1.3; 0.2; 0.1; 0.0; 0.0; 0.2; 0.6; 1.1; 1.3; 1.5; 6.2 (cumulative entries shown).
  - Identified debt‑creating flows (2012 onward): 6.0; 5.9; 3.9; 1.5; -0.8; -0.7; -0.3; 0.2; 0.9; 1.8; 2.6; 3.3; 3.4; 12.0 (cumulative entries shown).
  - Primary deficit (percent of GDP): 4.8; 6.3; 3.6; 3.5; 2.5; 2.1; 1.7; 1.5; 1.6; 1.6; 1.7; 1.7; 1.5; 19.5 (cumulative).
  - Primary (noninterest) revenue and grants (percent of GDP): 29.1; 28.5; 30.3; 31.0; 31.5; 31.5; 31.2; 31.0; 30.8; 30.8; 30.8; 30.9; 31.0; 310.5 (table lists values with cumulative column heading).
  - Primary (noninterest) expenditure (percent of GDP): 34.0; 34.8; 33.8; 34.5; 34.0; 33.6; 32.9; 32.5; 32.5; 32.4; 32.5; 32.7; 32.5; 330.0.
- Automatic debt dynamics and contributions (selected):
  - Interest rate/growth differential sequence (percent): 1.1; -0.4; 0.4; -2.0; -3.3; -2.8; -2.0; -1.4; -0.7; 0.1; 1.0; 1.6; 1.9; -7.5 (as presented).
  - Of which: real interest rate contributions (percent): 2.2; 2.2; 2.2; -0.3; -0.2; 0.3; 1.0; 1.4; 1.9; 2.4; 3.1; 3.7; 4.1; 17.4.
  - Of which: real GDP growth contributions (percent): -1.1; -2.6; -1.9; -1.7; -3.1; -3.1; -3.0; -2.8; -2.7; -2.3; -2.1; -2.1; -2.2; -24.9.
  - Exchange rate depreciation contribution: 0.0; 0.0; 0.0 (no further projected exchange rate depreciation entries).
  - Residual, including asset changes (percent): -1.1; -2.5; -1.8; -0.3; 1.0; 0.7; 0.2; -0.2; -0.7; -1.2; -1.6; -2.0; -1.9; -5.8.
- Notes:
  - Public sector defined as general government.
  - Projections assume key variables remain at last projection year level for debt‑stabilizing balance calculations.

---

### Annex Table 4 — Composition of public debt and alternative scenarios
- Underlying baseline assumptions (selected annual values):
  - Baseline Real GDP growth (2014–2023): 2014 = 1.7; 2015 = 3.0; 2016 = 3.0; 2017 = 2.9; 2018 = 2.8; 2019 = 2.6; 2020 = 2.3; 2021 = 2.1; 2022 = 2.1; 2023 = 2.1.
  - Baseline Inflation (2014–2023): 2014 = 1.6; 2015 = 1.8; 2016 = 1.9; 2017 = 2.0; 2018 = 2.0; 2019 = 2.0; 2020 = 2.1; 2021 = 2.0; 2022 = 2.0; 2023 = 2.0.
  - Baseline Primary balance (2014–2023): -3.5; -2.5; -2.1; -1.7; -1.5; -1.6; -1.6; -1.7; -1.7; -1.5.
  - Baseline Effective interest rate (2014–2023): 1.4; 1.6; 2.2; 3.0; 3.5; 4.0; 4.5; 5.0; 5.6; 5.9.
- Alternative scenarios presented:
  - Historical scenario: Primary balance held at -5.0 from 2015 onward; Effective interest rate path differs (e.g., 2014 = 1.4; 2015 = 1.6; 2016 = 2.6; 2017 = 3.9; 2018 = 4.7; 2019 = 5.6; 2020 = 7.0; 2021 = 7.6; 2022 = 8.2; 2023 = 8.5).
  - Constant Primary Balance scenario: Primary balance fixed at -3.5 across projection horizon; Effective interest rate alternative series shown (e.g., 2014 = 1.4; 2015 = 1.6; 2016 = 2.2; 2017 = 3.0; 2018 = 3.5; 2019 = 4.0; 2020 = 5.2; 2021 = 5.7; 2022 = 6.1; 2023 = 6.3).
- Composition charts (presented in source):
  - Gross nominal public debt (percent of GDP) time series and projection (2012–2023).
  - Public gross financing needs (percent of GDP) time series and projection (2012–2023).
  - By maturity: medium and long‑term vs short‑term (percent of GDP) historical and projection series.
  - By currency: local currency‑denominated vs foreign currency‑denominated (percent of GDP) historical and projection series.

---

### Annex Table 5 — Stress tests (macro‑fiscal and additional)
- Stress test scenarios and underlying assumptions (selected):
  - Primary Balance Shock scenario underlying series (2014–2023):
    - Real GDP growth: 1.7; 3.1; 3.1; 3.0; 2.8; 2.6; 2.3; 2.1; 2.1; 2.1.
    - Inflation: 1.6; 1.8; 1.9; 2.0; 2.0; 2.0; 2.1; 2.0; 2.0; 2.0.
    - Primary balance: -3.5; -4.3; -4.0; -1.7; -1.5; -1.6; -1.6; -1.7; -1.7; -1.5.
    - Effective interest rate: 1.4; 1.6; 2.2; 3.1; 3.6; 4.1; 5.3; 5.8; 6.3; 6.5.
  - Real GDP Growth Shock scenario underlying series (2014–2023):
    - Real GDP growth: 1.7; 1.1; 1.1; 1.2; 2.9; 2.8; 2.6; 2.3; 2.1; 2.1.
    - Inflation: 1.6; 1.3; 1.4; 2.0; 2.0; 2.0; 2.1; 2.0; 2.0; 2.0.
    - Primary balance: -3.5; -4.1; -4.3; -3.3; -1.5; -1.6; -1.6; -1.7; -1.7; -1.5.
    - Effective interest rate: 1.4; 1.6; 2.2; 3.1; 3.5; 4.1; 5.3; 5.8; 6.3; 6.5.
  - Real Interest Rate Shock scenario underlying series (2014–2023):
    - Real GDP growth: 1.7; 1.8; 2.0; 2.3; 2.4; 2.4; 2.1; 1.9; 1.9; 1.9.
    - Inflation: 1.6; 1.8; 1.9; 2.0; 2.0; 2.0; 2.1; 2.0; 2.0; 2.0.
    - Primary balance: -3.5; -2.5; -2.1; -1.7; -1.5; -1.6; -1.6; -1.7; -1.7; -1.5.
    - Effective interest rate: 1.4; 1.6; 2.5; 3.7; 4.5; 5.3; 6.8; 7.5; 8.2; 8.5.
  - Real Exchange Rate Shock scenario underlying series (2014–2023):
    - Real GDP growth and inflation on baseline paths; effective interest rate series shows modest deviations (e.g., 2014 = 1.4; 2015 = 1.6; 2016 = 2.2; 2017 = 3.0; 2018 = 3.4; 2019 = 4.0; 2020 = 5.3; 2021 = 5.8; 2022 = 6.3; 2023 = 6.5).
  - Combined Shock scenario underlying series (2014–2023):
    - Real GDP growth: 1.7; 1.1; 1.1; 2.3; 2.4; 2.4; 2.1; 1.9; 1.9; 1.9.
    - Inflation: 1.6; 1.3; 1.4; 2.0; 2.0; 2.0; 2.1; 2.0; 2.0; 2.0.
    - Primary balance: -3.5; -4.6; -4.3; -3.3; -1.5; -1.6; -1.6; -1.7; -1.7; -1.5.
    - Effective interest rate: 1.4; 1.6; 2.6; 3.8; 4.5; 5.3; 6.8; 7.4; 8.1; 8.4.
- Stress test outcomes (charts and series shown in source):
  - Gross nominal public debt responses presented in percent of GDP and percent of revenue under baseline and shocks.
  - Public gross financing needs responses presented in percent of GDP under baseline and shocks.

---

### Annex III — U.S. responses to past policy advice (summary of staff advice and developments)
- Fiscal policy:
  - Staff emphasized a medium‑term fiscal consolidation plan to restore long‑run fiscal sustainability and early action to slow entitlement spending.
  - Political consensus for a comprehensive plan remains unfavorable.
  - Cost‑saving measures in the Affordable Care Act appear to be lowering health care inflation.
  - Staff recommended replacing automatic spending cuts (the sequester) with back‑loaded savings and a more balanced, gradual near‑term consolidation.
  - Bipartisan Budget Act of December 2013 raised sequester spending caps for 2014 and 2015 in exchange for savings in future years.
  - Suspending the debt ceiling until March 2015 and passing the Consolidated Appropriations Act in early 2014 reduced fiscal uncertainties.
- Monetary policy:
  - Staff supported a highly accommodative monetary policy given a large output gap and well‑anchored inflation expectations.
  - Staff stressed the importance of effective communications; the Fed increased communications via FOMC statements, press conferences, and speeches.
- Financial policies:
  - Substantial progress achieved on national and global financial reform (including Basel III and finalization of the Volcker rule).
  - Remaining items include reforms on regulation of money market mutual funds.
- Housing policy:
  - Staff urged reduction of regulatory uncertainty (e.g., risks banks might repurchase defaulted loans from GSEs).
  - Measures taken to lessen these uncertainties; staff called for rapid completion of Qualified Residential Mortgage standards and legislative advances on housing finance—legislative proposals have moved forward but passage remains unlikely.
- Structural policies:
  - Administration launched initiatives for job training and apprenticeships consistent with staff recommendations.
  - Building political consensus for tax reform toward a less complex system with broader base and lower rates remains difficult.
  - No plan to introduce a VAT or a carbon tax.

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### Annex IV — External Stability Assessment: United States overall assessment
- Foreign asset and liability position and trajectory:
  - NIIP declined from -15 percent of GDP in 2010 to -27 percent of GDP in 2013.
  - Gross assets ≈ 130 percent of GDP; gross liabilities ≈ 160 percent of GDP.
  - U.S. has a positive net equity position and a negative net debt position due to sizable foreign holdings of U.S. Treasuries and corporate bonds.
  - Under staff baseline, U.S. NIIP projected to deteriorate by about 5 percentage points of GDP over the next five years.
- Assessment of risks:
  - Risks could arise from a decline in foreign demand for U.S. debt securities, potentially driven by failure to restore long‑run fiscal sustainability.
  - Given the dollar’s reserve currency status, current vulnerabilities are limited.
  - Most U.S. foreign assets are foreign‑currency denominated; over 50 percent are FDI and portfolio equity claims, which tend to decline when global growth and stock markets are weak or when the U.S. dollar appreciates.
- Overall staff assessment:
  - The U.S. external position is broadly consistent with medium‑term fundamentals and desirable policies.
  - Improvements in assessed imbalances and fiscal policy gaps noted; unconventional energy production boom contributed to improvement.
  - The positive terms of trade shock from energy production expected to boost national saving, partially offsetting stronger domestic investment.
- Potential policy responses (staff recommendations):
  - Over the medium term, fiscal consolidation should aim for a general government primary surplus of about 1¼ percent of GDP (corresponding to a federal government primary surplus of about 2 percent, which is higher than the 1½ percent surplus envisaged in the President’s budget and staff’s projection of a small deficit).
  - Implement structural policies to raise productivity and labor force growth, including steps to fully exploit benefits of unconventional energy production—consistent with maintaining external stability and achieving full employment.
- Current account:
  - CA deficit narrowed from pre‑crisis 6 percent of GDP to 2.3 percent in 2013.
  - Projected to widen to about 2¾ percent of GDP by 2019 due to stronger private demand closing the output gap, tempered by improvement in energy balance.
  - EBA model estimates a CA gap of -1 percent of GDP for 2013.
  - Staff assesses cyclically‑adjusted current account to be between 0 and 1.5 percent of GDP weaker than level implied by fundamentals and desirable policies.
- Real exchange rate (REER):
  - REER appreciated by about 2 percent during 2013, but remains around 10 percent below its average over past two decades.
  - Indirect REER estimates suggest some overvaluation (within 0 to 10 percent); direct EBA analyses suggest an undervaluation of around 8 percent in 2013.
  - Taking both methodologies and uncertainty from energy boom into account, staff assesses REER to be broadly in line with fundamentals with a range of -5 percent to +10 percent.
- Capital and financial accounts:
  - Inflows and outflows picked up in 2013 but remain lower than pre‑Lehman levels.
  - Portfolio inflows halved in 2013 relative to 2012; bank inflows strengthened.
  - U.S. dollar reserve currency status and safe‑haven motives support demand for U.S. Treasuries during turbulence.
  - United States has a fully open capital account; vulnerabilities limited by reserve currency status and safe‑haven role.
- FX intervention and reserves:
  - Dollar has global reserve currency status; U.S. reserves typically low relative to standard metrics and the currency is free floating.

*Source: IMF staff.*

### Annex IV. External Stability Assessment

### Annex IV. External Stability Assessment

### Recent developments and short-term indicators
- Economic activity: Contraction in growth of 2.9 percent in the first quarter of 2014 following acceleration in the second half of 2013.
- Recent indicators (July 2014): Jobless claims fell; job openings rose in May to their highest levels since August 2007; retail sales growth in June was solid with upward revisions for April and May; July homebuilder’s index increased; Fed’s Empire manufacturing index for July at its highest level since May 2010; industrial production grew at (an annualized) 5.5 percent in the second quarter.
- Fed communication: Chair Yellen testified that “almost all” FOMC participants expected the first rate hike at some time in 2015 and that asset purchases would likely conclude after the October FOMC meeting.

### Outlook and growth projections
- 2014: Activity projected to accelerate in the remainder of 2014 to well-above potential (in the 3–3½ percent range), but annual growth for 2014 is projected at 1.7 percent due to the first-quarter contraction.
- 2015: Growth projected to accelerate to the fastest annual pace since 2005 (Table projections below).
- Medium term: Potential growth forecast to average just above 2 percent for the next several years, reflecting aging population and more modest productivity prospects.
- Risks to outlook:
  - Slowing growth in emerging markets.
  - Oil price spikes related to events in Ukraine and Iraq.
  - Earlier-than-expected interest rate rises.
  - Upside possibilities: stronger nonresidential investment and a bounceback in labor force participation.

### Labor market, inflation, and monetary policy stance
- Labor market: Continued improvement but still-elevated unemployment rate, depressed participation rates, and slow pace of wage growth imply considerable slack remains.
- Monetary policy: Current highly accommodative stance considered appropriate by Directors; forward guidance welcomed. Recommendation for careful monitoring of wage developments and financial stability risks, and for clear, systematic communication to ensure smooth normalization.
- Fed assessment of financial stability risks described as moderate at that stage.

### Fiscal developments and recommendations
- Mid-Session Budget Review: Growth projection for 2014 revised down from 3.1 percent (March Budget) to 2.4 percent; implies modestly larger fiscal deficits and higher debt-to-GDP over the medium term. Federal deficit for FY2014 and 2015 revised down by around ¼ percent of GDP in each year (to 3.4 and 2.9 percent of GDP respectively) due to slower-than-expected spending in various programs.
- Fiscal policy advice:
  - Need for medium-term fiscal adjustment to ensure a downward path for public debt.
  - Importance of reaching agreement on a credible medium-term fiscal consolidation plan.
  - Scope identified for expanding near-term budget envelope in areas with high and lasting growth impact, funded by future savings, including upfront action to control health care and entitlement spending.
  - Steps to improve budget procedures and the institutional framework to reduce uncertainty.

### Financial sector and regulatory issues
- Progress noted on implementing Dodd-Frank Act, finalizing the Volcker rule, and designating another systemically important financial institution.
- Rule requiring certain foreign bank organizations to incorporate as holding companies aligns treatment of foreign and U.S. banks and eliminates a regulatory distortion.
- Directors called for continued vigilance on potential systemic risks associated with prolonged low interest rates, particularly among nonbank intermediaries, and emphasized macroprudential framework, tightened supervision, and prudential norms across banks and nonbanks.
- Regulatory cooperation: On July 8, US Treasury and European Commission reiterated commitment to cooperate on OTC derivatives regulation and cross-border resolution.

### Social and structural concerns
- Inclusion: Recent growth not particularly inclusive; latest data point to almost 50 million Americans living in poverty (Census Bureau’s supplemental poverty measure) and official poverty rate stuck above 15 percent.
- Policy recommendations: Raise productivity, encourage innovation, augment human and physical capital, increase labor force participation; pursue investments in infrastructure and education, comprehensive tax reform, active labor market policies, skills-based immigration reform; consider expansion of the Earned Income Tax Credit and possibly a higher minimum wage to address poverty and inequality while promoting labor participation.

### Selected economic projections and key indicators (from Table 1)
- Real GDP: 2012: 2.8; 2013: 1.9; 2014: 1.7; 2015: 3.0; 2016: 3.0; 2017: 2.9; 2018: 2.8; 2019: 2.6
- Net exports (contribution): 2012: 0.1; 2013: 0.1; 2014: -0.2; 2015: -0.2; 2016: -0.3; 2017: -0.2; 2018: -0.1; 2019: -0.1
- Total domestic demand: 2012: 2.6; 2013: 1.7; 2014: 1.8; 2015: 3.2; 2016: 3.2; 2017: 3.1; 2018: 2.8; 2019: 2.7
- Private final consumption: 2012: 2.2; 2013: 2.0; 2014: 2.2; 2015: 2.9; 2016: 2.8; 2017: 2.7; 2018: 2.7; 2019: 2.7
- Gross fixed domestic investment: 2012: 5.5; 2013: 2.9; 2014: 2.4; 2015: 6.3; 2016: 7.1; 2017: 6.1; 2018: 4.4; 2019: 3.3
- Residential structures: 2012: 12.9; 2013: 12.2; 2014: 3.2; 2015: 13.4; 2016: 14.6; 2017: 11.2; 2018: 4.2; 2019: 3.4
- Nominal GDP: 2012: 4.6; 2013: 3.4; 2014: 3.3; 2015: 4.9; 2016: 4.9; 2017: 5.0; 2018: 4.8; 2019: 4.7
- Personal saving rate (percent of disposable income): 2012: 5.6; 2013: 4.5; 2014: 4.3; 2015: 4.0; 2016: 4.2; 2017: 4.3; 2018: 4.1; 2019: 4.0
- Unemployment rate: 2012: 8.1; 2013: 7.4; 2014: 6.4; 2015: 6.0; 2016: 5.8; 2017: 5.6; 2018: 5.5; 2019: 5.5
- CPI inflation: 2012: 2.1; 2013: 1.5; 2014: 1.8; 2015: 1.8; 2016: 1.9; 2017: 2.0; 2018: 2.0; 2019: 2.0
- Core PCE Inflation: 2012: 1.8; 2013: 1.2; 2014: 1.4; 2015: 1.7; 2016: 1.7; 2017: 1.8; 2018: 1.9; 2019: 2.0
- Output gap (percent of potential GDP): 2012: -4.0; 2013: -3.8; 2014: -4.0; 2015: -2.9; 2016: -2.0; 2017: -1.1; 2018: -0.6; 2019: 0.0
- Federal balance (percent of GDP, fiscal years): 2012: -6.7; 2013: -4.5; 2014: -3.5; 2015: -3.1; 2016: -3.2; 2017: -3.1; 2018: -3.1; 2019: -3.5
- Debt held by the public (percent of GDP): 2012: 70.1; 2013: 72.0; 2014: 74.2; 2015: 74.5; 2016: 74.6; 2017: 74.5; 2018: 74.4; 2019: 74.7
- General government gross debt (percent of GDP): 2012: 102.0; 2013: 104.0; 2014: 105.8; 2015: 106.0; 2016: 106.0; 2017: 106.0; 2018: 106.0; 2019: 106.2
- Three-month Treasury bill rate (percent): 2012: 0.1; 2013: 0.1; 2014: 0.1; 2015: 0.3; 2016: 1.2; 2017: 2.2; 2018: 3.3; 2019: 3.8
- Ten-year government bond rate (percent): 2012: 1.8; 2013: 2.4; 2014: 2.7; 2015: 3.3; 2016: 4.0; 2017: 4.5; 2018: 5.0; 2019: 5.1
- Current account balance (percent of GDP): 2012: -2.8; 2013: -2.4; 2014: -2.4; 2015: -2.6; 2016: -2.8; 2017: -2.8; 2018: -2.8; 2019: -2.7
- Net international investment position (percent of GDP): 2012: -23.8; 2013: -27.2; 2014: -28.7; 2015: -29.5; 2016: -30.4; 2017: -31.3; 2018: -32.1; 2019: -32.8
- Gross national saving (percent of GDP): 2012: 16.2; 2013: 17.1; 2014: 17.1; 2015: 17.6; 2016: 18.2; 2017: 18.8; 2018: 19.2; 2019: 19.4
- Gross domestic investment (percent of GDP): 2012: 19.0; 2013: 19.5; 2014: 19.6; 2015: 20.2; 2016: 21.0; 2017: 21.6; 2018: 21.9; 2019: 22.1

*Source: IMF staff report and staff representative statement for the 2014 Article IV Consultation with the United States.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14221.pdf_