2014 Article IV Consultation with the United States of America Concluding Statement of the IMF Mission
IMF News, June 16, 2014
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- Published: June 16, 2014
Key themes and overall policy focus
- Five broad themes to strengthen the recovery and improve the long-term outlook: raising productivity growth and labor participation; confronting poverty; keeping public debt on a sustained downward path; managing the exit from zero policy rates; and securing a safer financial system.
- Policy focus recommended: undertake more proactive labor market policies to lower long-term unemployment and raise participation; increase the minimum wage while strengthening the Earned Income Tax Credit; invest in infrastructure; improve the tax structure and raise revenues; fundamentally reform social security; and lower the growth of health care costs.
Growth and poverty reduction
- Near-term growth and jobs:
- Growth projected at 2 percent for 2014, rising to 3 percent in 2015.
- Recent factors that weakened early-2014 momentum: a harsh winter, inventory drawdown, a still-struggling housing market, and slower external demand; recent data suggest a meaningful rebound underway.
- Current account deficit expected to slowly widen as imports rise, only partially offset by fiscal consolidation and energy self-sufficiency improvements.
- Labor market: job growth healthy but weaker beneath the surface—long-term unemployment high, labor force participation well below what demographic factors explain, and wages stagnant.
- Headline unemployment expected to decline only slowly as improving prospects draw discouraged workers back into the labor force; long-term unemployment will take time to fall to historic levels.
- Longer-run growth:
- Potential growth forecast to average around 2 percent for the next several years.
- Downward pressures include population aging and more modest productivity prospects.
- Recommended measures: investments in infrastructure and education; improving the tax system; active labor market policies; potential skills-based immigration reform; capitalizing on rising U.S. energy independence (including removing existing restrictions on U.S. oil exports).
- Poverty:
- Latest data showed almost 50 million Americans living in poverty (Census Bureau’s supplemental poverty measure).
- Official poverty rate stuck above 15 percent despite the recovery.
- Policy measures to reduce poverty: stronger growth and job creation; expanded Medicaid and increased health insurance coverage; expanded Earned Income Tax Credit (apply to households without children, older workers, and low income youth); make permanent EITC extensions and Child Tax Credit improvements due to expire in 2017; increase the minimum wage.
Macroeconomic and financial policies
- Macroeconomic policy mix:
- With substantial economic slack, strong case for continued policy support.
- Ideal approach: approve and implement a credible medium-term fiscal consolidation plan to provide flexibility for near-term fiscal support focused on productivity, capital stock, and labor supply—allowing earlier withdrawal of exceptional monetary stimulus and reducing financial stability risks.
- Political agreement on this approach remains elusive.
- Monetary policy stance:
- Fed faces uncertainty about remaining labor market slack, transmission of slack to wages and prices, and transmission of future rate increases to the real economy.
- Staff baseline: economy expected to reach full employment only by end-2017 and inflationary pressures expected to remain muted.
- If baseline holds, policy rates could stay at zero for longer than the mid-2015 date currently foreseen by markets, but policy must remain cognizant of financial stability risks.
- If inflation rises more rapidly while the economy is still below full employment, tolerating a modest, temporary rise of inflation above the longer-term goal could be consistent with the Fed’s balanced approach, provided inflation expectations remain anchored and financial stability risks are low.
- Federal Reserve communication:
- Recent shift to qualitative forward guidance increases flexibility but raises the premium on clear, systematic communication.
- Suggested enhancements: schedule press conferences by the Fed Chair after each FOMC meeting; publish a quarterly monetary policy report endorsed by the FOMC conveying majority views, uncertainties, and dissenting views; provide greater clarity on how financial stability considerations factor into monetary policy.
- Financial stability risks:
- Progress: banks stronger, corporate balance sheets healthy, overall leverage contained, regulatory framework improved.
- Ongoing concerns due to prolonged very low interest rates, especially in nonbank intermediaries:
- The growing amount of maturity and liquidity transformation through mutual funds or exchange traded funds, particularly those investing in credit instruments;
- The ongoing weakening of underwriting standards in some areas, particularly those linked to lending to leveraged corporations with higher credit risks;
- The volume of flows searching for returns and flowing into higher credit risk and longer duration assets;
- The uncertain leverage and risks embedded in securities lending undertaken by large financial institutions;
- The fragmented oversight of the insurance sector, data gaps, and the lack of a consolidated picture of insurance companies’ global activities and risks;
- A decline in broker-dealer involvement in market making activity, potentially hampering market functioning and price discovery at times of stress.
- Tail-risk scenario: a precipitous investor exit—exacerbated by outflows from ETFs and mutual funds and near-term market illiquidity—could trigger abrupt, self-reinforcing re-pricing of financial assets, damaging U.S. growth (via wealth effects and financing strains) and causing international knock-on effects.
- Regulatory action recommended:
- Further supervisory scrutiny on underwriting standards.
- Higher risk weights and tighter limits on large exposures to certain assets (such as leveraged loans or high yield bonds).
- Stronger prudential norms for holding securitized loans (such as CLOs) by regulated entities.
- Address vulnerabilities of money market funds and the tri-party repo market.
- Continue implementing measures for orderly resolution of too-important-to-fail institutions and deepen cross-border resolution cooperation.
- Insurance sector: stronger and more uniform capital adequacy and solvency oversight, refine/harmonize stress testing, close data gaps, designate additional systemically important firms, and consider a larger federal role in insurance regulation and oversight.
- U.S. should lead in advancing global regulatory reform to ensure common practices, limit regulatory arbitrage, and remain attuned to international spillovers.
Housing finance
- Mortgage finance constraints:
- Limited availability of mortgage financing is a pressing constraint on growth.
- Conservative lending driven by “put-back” risk, litigation and reputational risks, a tighter regulatory environment, and uncertainty about the mortgage industry’s future structure.
- Measures already taken: “safe harbor” for Qualified Mortgages and clarifications on put-back conditions.
- Recovery of mortgage lending to lower credit-rated borrowers likely to be slow.
- End objectives for housing finance reform:
- 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;
- A common platform for securitization;
- Clear delineation and transparent accounting of public interventions intended to promote social objectives.
- Interim administrative actions (in anticipation of legislative reform):
- Expand 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.
Fiscal policy: near-term, medium-term, and institutional reforms
- Near-term fiscal policy:
- Bipartisan Budget Act (December 2013) and raising the debt ceiling reduced fiscal risks.
- Room exists to expand the near-term budget envelope funded by offsetting savings in future years.
- Specific near-term measures supported (many in the Administration’s budget proposal):
- Front-loaded infrastructure spending, with urgency on surface transportation and clarity on financing the Highway Trust Fund; sustained Federal and State increases paid for by entitlement savings, additional revenues, and expanded financing sources (including innovations such as the America Fast Forward Bond).
- Changes in the tax system: limit or gradually eliminate itemized deductions for the individual income tax (including the mortgage interest deduction); significantly increase the Federal gas tax; reinstate and make permanent the Research and Experimentation tax credit that expired at end-2013; consider time-bound tax credits or wage subsidies to employers who hire the long-term unemployed.
- Education spending reoriented to prioritize early childhood education (including universal pre-K) and greater support to science, technology, engineering and math programs.
- Medium-term consolidation:
- General government debt not on a sustainable longer-term path and likely to begin rising again by 2018.
- To place debt on a downward trajectory, staff believe a general government primary surplus of 1¼ percent of GDP by 2023 will be needed.
- Adjustment measures should include:
- Controlling health care costs through better coordination of services for chronic conditions, greater cost sharing with beneficiaries, and limiting tax breaks for higher cost, employer-provided health plans.
- Strengthening social security finances via fundamental reform: further gradual increases in the retirement age (perhaps linked to life expectancy), increasing the ceiling on taxable earnings for social security, and indexing benefits and tax provisions to chained CPI.
- Improving the tax structure and raising revenues: broad corporate tax reform to lower the marginal rate, simplify the system, eliminate exclusions and deductions, limit base erosion and profit shifting; introduce a broad-based carbon tax; move toward a Federal-level VAT.
- Institutional fiscal reforms:
- Recommendations to lessen fiscal policy uncertainty and avoid brinkmanship:
- Reach bipartisan agreement on a clear, simple medium-term fiscal objective with an integrated view of budget functions and numerical targets for debt and deficit;
- Adopt mechanisms to trigger revenue or spending adjustments if targets are breached;
- Implement an automatic process that raises the debt ceiling once agreement on broad budget parameters is reached;
- Shift to a budget cycle where annual spending levels are agreed for a two year period, with specified conditions for supplemental resolutions.
Conclusion
- The agenda ahead is long and challenging and will take many years to accomplish.
- Concerted progress would raise long-run growth prospects, lessen poverty, put fiscal finances on a sustainable footing, and reduce financial stability risks—beneficial for the U.S. and the world economy.
Source: Mission Concluding Statement, 2014 Article IV Consultation with the United States of America, June 16, 2014.