Transcript of a Conference Call on USA Article IV Consultation

July 26, 2013

Washington, D.C.
Friday, July 26, 2013

MR. ANSPACH: Hello, everybody. This is Raphael Anspach, with the IMF’s Communications Department. Thank you for joining this teleconference on the 2013 U.S. Article IV . You’ve seen the documents that we provided to you under embargo. The embargo is on until 10:30 Washington time today. That also applies to the comments made at this teleconference.

With me today to lead this teleconference, I have Mr. Gian Maria Milesi-Ferretti who’s the IMF Mission Chief for the U.S.A. and Deputy Director of the IMF’s Western Hemisphere department and Mr. Roberto Cardarelli who’s the Division Chief of the IMF’s North American Division in the same department.

Before we take your questions, Mr. Gian Maria Milesi-Ferretti will have some introductory remarks and then we’ll be happy to field your questions.

Gian Maria, would you like to start, please?

MR. MILESI-FERRETTI: Thank you all and good morning. I will just say a few words since you’ve had an opportunity to look at the report.

So, if we look at the outlook for the U.S. economy, we have a forecast for modest growth this year, 1.7 percent on a period-average basis, and an acceleration of growth to 2.7 percent next year. Now despite the fact that growth this year is forecast to be quite a bit slower than last year, I would say that overall the tone of our assessment of the outlook is better. We think there is more underlying strength in the U.S. economy, and we think that the reason why growth this year is going to be low is the very large reduction in the fiscal deficit, with tax increases and the expenditure cuts that have taken a toll on economic activity. As this contraction from the fiscal side is forecast to wane over next year, we see more resilient private sector demand asserting itself and growth accelerating to close to 3 percent during this period.

Our assessment of the fiscal situation in the U.S. has had two colors if you want. On one hand there is an underlying improvement in fiscal accounts. Those are reflected both in the fact that overall fiscal deficit has been declining very rapidly, but also that the longer term outlook for expenditures and revenue has improved somewhat thanks to a lower rate of growth in health care costs than previously forecast and also more buoyant revenues than previously forecast.

Now this is the positive. Still we see two problems. One is that you have excessively rapid fiscal consolidation in the short run. As I mentioned the recovery is still weak, yet you have a very large reduction in the deficit. We think that it would be more advisable to have a slower pace of fiscal consolidation in the short run that would allow the recovery to take hold. And instead what we still need is more action to reduce the longer run pressures on the budget, and those are reflected primarily in spending for entitlements. And we think that reforms that are designed to slow the rate of growth of entitlement spending and to balance with some increase in revenues would help put U.S. public finances finally on a sustainable basis over the longer term. As I said, over the short term, things are looking better, also thanks to the fact that interest costs are very low. But you still have a long-term problem.

Monetary policy has been -appropriately-, extremely supportive of the recovery. It has helped the recovery of the housing market, which is really the key underlying feature of the recovery in private sector demand both because of the recovering construction and because of the positive effects of the recovering house prices on household balance sheets.

We think that the strategy of the Federal Reserve to condition the pace of reduction in its purchases of assets to the performance of the economy is wise and a key to maintain the needed momentum for the recovery. Close attention needs to be paid, of course, to the financial stability considerations in an environment in which interest rates have been low for long. We’ve had a bout of volatility in recent weeks that shows that even with a clear strategy and clear conditions, you can have periods of volatility and financial institutions and, of course, the regulators need to be ready for that.

On the financial sector outlook, I would like to say that over the past few weeks we’ve had a number of important measures that we had been pressing for that have been adopted on a final basis. I would want to mention the Basel III capital requirements with the final regulations issued just a couple of weeks ago. Also the process of designation of systemically important non-bank financial institutions is coming to a conclusion with the first institutions being singled out for enhanced supervision. We think that is very important.

And as you know, the U.S. plays a crucial role in global financial markets, and it is extremely important for good function in the global financial systems that the international financial reform agenda is closely coordinated. And in this regard we are very encouraged by the recent news on the agreement in the area of over-the-counter derivatives that has been reached by the Commodity Futures Trading Commission with international counterparts.

I think I’ll stop here, and I’m happy to take your questions.

QUESTIONER: Yes, good morning and thanks for doing this. My question goes to the political area. The report says that political gridlock in Congress makes problems for legislative action clear, and this obviously will affect or could affect the economic outlook for next year. And the question basically is how much the upcoming political fight about the debt [ceiling] and the deficit reduction could weigh in in this regard, especially because so far it doesn’t seem like there could be an agreement between the Republicans and the Democrats in the White House?

MR. MILESI-FERRETTI: Thank you very much for your question. Yes, there are clearly differences in views on the appropriate strategy for fiscal policy going forward within Congress. I would want to, if you’ll allow me to split your question in two parts. Let me deal first with the debt ceiling. I think we had a major bout of financial instability and a slowdown in growth associated with what happened over the summer of 2011, and we are confident this is an experience that nobody wants to repeat. And we think, therefore, that there is every reason not to want to create any tension around the creditworthiness of the U.S. government by prolonging an impasse over the debt ceiling. It’s something that is absolutely essential to solve successfully, the earlier the better for the financial markets, but [also] for the real economy [and] confidence. But we are also confident that the importance of this is not lost among decision makers.

The second part concerns the strategy going forward for spending and revenues, and I would think in particular for what is going to happen to the spending cuts known as the sequester. Our assessment is that the sequester is costly in terms of economic growth and an inefficient way to cut spending. And, indeed, it was designed precisely with those features to convince the legislators to come up with budgetary savings under the threat of something that was unpleasant and costly. So I think I’m not saying something that people would strongly take issue with since this was precisely the purpose or the design of this mechanism.

Still, given that at the moment we don’t have a clear indication that the sequester is going to be replaced, we are assuming that the caps on discretionary spending that the sequester imposes will remain in place for 2014. If a solution is found that, say, replaces these tighter caps in spending in the short run with measures that are more back-loaded that take effect more later when the recovery is better established, that would be good news for U.S. growth in our view even though it will imply a slightly larger fiscal deficit next year. That’s something we would very much support.

But I want to say that our forecast at the moment incorporates a continuation of these tight caps on discretionary spending, but we do assume that the debt ceiling is going to be raised without disruption.

QUESTIONER: Thank you for taking my call. I was wondering if you could talk more about the Fed’s asset purchase plan. Do you think that it’s okay for them to start slowing down in September or is that too early?

MR. FERRETTI: We think that the strategy to tailor the pace of tapering to what is happening to the recovery is [the right one] and depending on your outlook and your projections and outturns, of course, you could think that tapering would start a quarter before or a little bit later. Our forecasts for growth are for this year relatively weak. They are a bit weaker than the central forecast in the projection of the FOMC [Federal Open Market Committee], having exactly the same strategy in our policy line of tying the purchases to the outlook for the economy. We have them tapering off early next year, so continuing throughout this year.

But objectively we are talking about out-turns of data, of small differences in how strong the recovery’s going to be for the rest of the year. And one-quarter of difference in the slowing of purchases in terms of how much it should matter from a macroeconomic perspective or the impact on interest rates, we are talking about really small differences.

QUESTIONNER: So you’re saying not to move until December?

MR. MILESI-FERRETTI: Well, this is based on our outlook. The “reaction function” envisaged by the Federal Reserve is--we think--the right strategy. The issue is how we are going to see how well has GDP done in the second quarter and what are the indications of how the economy’s performing over the third quarter. And based on those considerations, one would take a decision presumably on whether the pace is going to be slowed in September or later in the year.

But I’m saying based on our forecast today, which is for a relatively weak rest of the year, that is what we have. We’d be happy to be wrong.

QUESTIONNER: I have a question regarding the effect of the tapering on emerging markets and the Eurozone. As we saw, just the mentioning by the Fed of this possibility has created some turbulence in the financial markets and this would at the end of the day reflect on lower global growth and it would again affect the U.S. economy. So how much do you think the Fed should worry about the global effect of its policy? Thank you.

MR. MILESI-FERRETTI: I would like to say a couple of things on this. So one thing that we need to take into account is what was the situation in mid-to-late May when the Federal Reserve Chairman mentioned with more precision in time and conditions the tapering of asset purchases. During the previous two months, you’ve had a very strong run-up in asset prices, unusually low volatility, and a number of observers were beginning to express concern about segments of financial markets being excessively frothy. And, indeed, long-term interest rates in the U.S. had declined quite significantly from about 2 percent in March to below 1.7 in May. So part clearly of what happened was also a reaction to a period of extremely low volatility and a very sharp run-up in asset prices. There was a very significant correction.

You saw over the last few weeks that markets have stabilized. You’ve had some increase in interest rates globally, some tightening of financial conditions, but not a dramatic one. What I would want to stress is that the strategy of the Federal Reserve is clearly tied to the expected performance of the U.S. economy. So real interest rates, long-term interest rates, will rise with a faster tapering or a bringing-forward of a normalization of short-term interest rates if the U.S. economy does better and grows faster than expected. And that part, the faster U.S. growth, is clearly good for the U.S. economy and good for the world.

So you have two aspects to it, the positive impact that is going to come from faster growth that is going to be tempered to some extent by the fact that interest rates are going to rise, reflecting again the strength of the U.S. recovery. But if you look at where rates are today, even in countries in the Eurozone, the increase in rates relative to increasing rates in the U.S., is considerably more modest.

QUESTIONNER: I have a question about the monetary policy, especially about the policy rates. In your scenario you said policy rates assumed to remain until early 2016. And also the large majority of FOMC members expect such increase to occur during 2015. I’d like to ask more specifically the reason why you said the rate remains at zero until early 2016.

MR. MILESI-FERRETTI: Thank you for your question. Again, it’s a good question, but it’s also one that is easy to answer for us. We think we have a slightly slower pace of recovery in our forecast than the majority of FOMC members. So we have the decline in unemployment that in our view would trigger the first increase in interest rates a few months later than what is assumed in the forecast of the FOMC. So that is the reason for the difference. We simply expect the recovery to be a little bit slower. Again, we are talking about the few months down the road, two years from now.

MR. ANSPACH: All right. So if there are no further questions, I would like to thank you for listening in, and to remind you that the comments and the report are embargoed until 10:30 today. For any other additional questions, do not hesitate to call us or write us an email at Thank you very much.


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