2000 Article IV Consultation with the United States of America
Statement of the Fund Mission
July 12, 2000
1. Sound monetary and fiscal policies have contributed to making the current U.S. economic expansion the longest on record. The federal fiscal balance has improved steadily since 1992, and budget surpluses were recorded in 1998 and 1999, the first time in more than 40 years that there were consecutive surpluses. Government debt held by the public has declined sharply as a share of GDP, and a continuation of current policies holds the prospect of eliminating the public debt early in the next decade. Monetary policy has helped the U.S. expansion to maintain its footing through a number of shocks, while inflation remains low and unemployment has fallen to levels not seen in 30 years. The favorable fiscal outlook, rising national saving, and low inflation have laid the foundation for strong investment spending which, in turn, has facilitated high rates of growth in both productivity and real income. The U.S. authorities are to be highly commended for these accomplishments.
2. The strength of the U.S. economic expansion played a critical role in supporting world economic growth during the period of turbulence in 1997-98, and it has also provided significant support to the global recovery that now appears to be well underway. This growth in U.S. domestic demand in excess of supply has been reflected in a large and growing external current account deficit. At the same time, large external surpluses in Japan and, to a lesser extent, in the euro area have emerged. The sustainability of the large U.S. current account deficit hinges on the ability of the United States to continue to attract sizable capital inflows. Up to now these inflows in large part have reflected the perceived attractiveness of the U.S. investment environment, but such perceptions are subject to continuous reappraisal. If the uneven pattern of world growth which has prevailed in recent years were to persist much longer, it would raise concerns that external imbalances among the major economies would widen further, increasing the risk of an abrupt reversal with potentially adverse consequences worldwide. Signs of stronger growth in the euro area are encouraging, but prospects for a significant pickup in demand in Japan are still unclear, and appropriate policies in these countries will be needed to promote the sustained expansion of their economies. In the United States, the policies that will best serve the key U.S. domestic objective of sustaining noninflationary growth will also contribute to a smooth rebalancing of global demand.
3. The strength of U.S. aggregate demand has been supported by rising real incomes, enhanced profitability, and rapidly growing household wealth—all of which are closely related to the surge in productivity experienced in the United States in the second half of the 1990s. This productivity surge also has been a primary factor underlying the attractive investment environment in the United States, drawing in substantial flows of capital, pushing up the value of the dollar, and contributing to a sharp widening of the current account deficit. The sustainability of current high stock market valuations will depend to a considerable extent on how prolonged will be the factors underlying the surge in productivity growth, and thus the outlook for corporate earnings. Capital deepening and the diffusion of information technologies appear to underlie much of the increase. At this juncture, there is no way of knowing how long this process might continue to support these high levels of productivity growth, with their associated favorable effects on real incomes, profits, and wealth. Nevertheless, it is clear that continued domestic demand growth at a pace well in excess of the productivity-driven increases in potential output is not sustainable. If not reined in, such rapid demand growth threatens to undermine the prospects for sustained noninflationary growth.
4. In these circumstances, the IMF staff believes that the principal policy priority for the United States in the near term is to ensure that the pace of aggregate demand growth is brought back in line with the economy's potential growth in supply in order to keep inflation in check. The prospect that those factors which have helped to contain inflationary pressures over the past few years—such as restrained growth in employee benefits and weak import and non-oil commodity prices—may begin to reverse adds to the need for decisive policy action to slow demand growth. The Federal Reserve has acted appropriately, raising short-term interest rates by a further 50 basis points at the May FOMC meeting. Although it did not raise the federal funds rate further in June, the FOMC indicated its concern that the risks going forward continued to be mainly weighted toward conditions that might generate heightened inflationary pressures. The IMF staff believes a further tightening of monetary policy will be required to ensure that inflation remains under control. How much more interest rates will need to be increased will depend on how the economy responds to past and subsequent steps to tighten policy, and whether there are additional indications of emerging wage and price pressures in the period ahead. Although tighter U.S. monetary policy will inevitably have spillover effects on the rest of the world, including for the cost of financing in the emerging market countries, the impact would be even more detrimental for these countries if the U.S. authorities were to delay a policy response and subsequently needed to tighten monetary policy more sharply once inflationary pressures had strengthened.
5. Fiscal policy also has an important role to play in restraining domestic demand growth in the near term. Preserving the fiscal surpluses in prospect entails the withdrawal of a significant stimulus to demand, whereas measures to substantially cut taxes or raise spending would add to demand at an inappropriate time and thereby jeopardize the continued noninflationary expansion of the economy. Indeed, a tightening of the fiscal stance would alleviate the burden on monetary policy, and reduce some of the upward pressure on U.S. interest rates that could increase the dollar's value and exacerbate global current account imbalances. By helping to raise the level of national saving, maintaining a tight fiscal position would also help to ensure an orderly correction in the current account imbalance and in the real value of the dollar over the medium term. Moreover, although the underlying fiscal position appears to be very solid, the simple fact that changing economic conditions could significantly alter medium-term budgetary prospects argues strongly for caution in introducing new expansionary fiscal measures; it would be better to use stronger-than-expected fiscal surpluses to pay down the public debt more rapidly.
6. To ensure that budget discipline is maintained, the Administration in its FY 2001 budget proposes to extend through FY 2010 the discretionary spending caps and the PAYGO financing requirement. These budget enforcement mechanisms have played an important role in the improvement in the fiscal position since 1992. Under the Administration's proposal, the discretionary spending caps would be raised in FY 2001 to reflect currently enacted levels of spending and to ensure that adequate levels of basic government services are maintained. Thereafter, the caps would rise roughly in line with inflation; PAYGO would be extended without modification. The IMF staff agrees that adjustments are necessary to make the discretionary spending caps more realistic; however, once this has been done and these budget enforcement mechanisms have been extended, the discipline imposed by the caps and PAYGO should be re-established.
7. In the FY 2001 Budget, the Administration continues its practice of proposing small targeted tax cuts to promote specific economic and social objectives. Repeated resort to such tax expenditures adds to the complexity of the tax code, undermining transparency and increasing compliance costs. The IMF staff continues to take the view that the authorities should limit recourse to the use of targeted tax cuts. The underlying objectives of most of the measures proposed might better be addressed through spending programs.
8. The Administration's intention to preserve a substantial portion of the budget surpluses in prospect under current services over the longer term is laudable, and the IMF staff welcomes the view recently expressed by the Secretary of the Treasury that there is a compelling argument for establishing as a medium-term fiscal policy objective the elimination of the net government debt held by the public. Elimination of the public debt would be an important step in preparing the federal government for the coming long wave of unfunded liabilities associated with the aging of the population, as the first of the baby-boom generation starts to retire around 2010. Indeed, to meet these obligations fully, the overall fiscal position may need to remain in surplus for a while even after the public debt has been retired. In this context, the IMF staff believes that a reasonable medium-term fiscal policy objective could be to adopt measures to eliminate the actuarial imbalances facing Social Security and Medicare Hospital Insurance (HI), and then attempt to keep the remainder of the budget roughly in balance on average over the business cycle. This might be facilitated if revenues and expenditures of Social Security and Medicare HI were more formally separated from the rest of the federal budget, in order to help mitigate pressures to divert surpluses in these programs to other uses.
9. The Administration's plan for strengthening the long-term financial outlook of Social Security and Medicare shores up their future economic viability by reducing the public debt and by transferring on-budget resources to the programs. Such resource transfers could risk softening budget constraints that have helped over the years to restrain spending, although this risk might be reduced by the Administration's proposal to link these transfers to part of the interest saving from retiring the public debt. However, once the precedent was set, it could be easier to justify transfers to finance extensions of benefits. In the view of the IMF staff, relatively small adjustments in the parameters of both the Social Security and Medicare systems (such as a combination of small payroll tax increases and benefit cuts), if put in place soon, would be sufficient to meet the future liabilities of the programs based on current estimates of these liabilities. Particularly in the case of Medicare, however, it has to be recognized that, because of the uncertainties associated with projecting future health care costs, additional periodic adjustments to the program's parameters are likely to be required, and a mechanism for routinely making such adjustments will need to be established. The IMF staff also takes the view that it would be better for the Administration to ensure that the current long-term financial shortfall is fully addressed before adopting new Medicare benefits.
10. Although at present the authorities do not see major vulnerabilities in the banking sector that might contribute to triggering a downturn in economic activity, they have been prudently cautious in their supervision of banks, and the IMF staff is impressed by their determination not to be complacent. Any downturn in the economy will inevitably produce some financial distress as falling incomes and profits create debt-servicing difficulties for some households and businesses. In this context, the IMF staff strongly supports the authorities' efforts to be pre-emptive and to limit the scope of such potential future financial distress by appropriately cautioning bank lending officers against loosening lending standards and making loans on the basis of the tenuous assumption that current favorable economic conditions will continue uninterrupted.
11. The Gramm-Leach-Bliley Act represents a much needed overhaul of the badly outdated laws regulating the financial sector in the United States. The expanded opportunities for new financial holding companies to engage in banking, securities, and insurance activities and the new regulatory supervisory structure provided for under the law pose significant new challenges. In particular, although the Act provides broad guidelines, it does not specifically lay out how the supervisory responsibilities of the Federal Reserve, the other federal banking agencies, and the nonbank functional supervisors (including the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the state-level insurance commissioners) are to be implemented in practice. To address concerns raised by some market participants about this division of responsibilities, the Federal Reserve is working to adapt its supervisory approach to ensure it is fully effective; to work more closely with other supervisory agencies; and to avoid an extension of the banking safety net. The authorities have rightly emphasized that the central supervisory challenge will be to ensure that the large, more complex financial institutions that are emerging have sufficiently robust risk-management systems. They have also indicated their interest in making more use of market information and discipline in supervising financial institutions. In this context, one possible approach that is being considered by the authorities is to require the regular issuance by large banks of a uniform subordinated debt instrument.
12. The strength of the U.S. economy has generally helped to contain protectionist pressures, even in the face of a strong dollar and the weakness of economic activity abroad. Nonetheless, U.S. antidumping (AD) and countervailing duty (CVD) actions increased in 1998 and 1999. It is in the interest of both the United States and the international community that protectionist pressures be strongly resisted. As a general rule, the Administration has stressed the importance of, and has taken measures aimed at, enhancing market competition throughout the economy. Consistent with this policy approach, the IMF staff believes that the implementation of AD/CVD trade remedies should not be used as a means of inhibiting market-based competition from imports. To this end, a change in procedures is called for, such that import protection would be provided only in those cases where foreign producers were found to be engaged in anticompetitive behavior.
13. The United States should continue to be a major force for the further liberalization of world trade through efforts to initiate a new round of multilateral negotiations and in the sectoral negotiations currently scheduled in the areas of agriculture and services. The United States has also worked constructively with authorities in other countries to reach a pragmatic solution to improve the functioning of the dispute-settlement mechanism, which is an essential element in the WTO's rules-based approach to international trade. The improvements in market access provided in the African Growth and Opportunity Act and in the Caribbean Basin Initiative are useful steps to enhance growth prospects for the countries of these regions, and the IMF staff encourages the authorities to broaden further duty-free access to the U.S. market for the least-developed countries.
14. Official development assistance (ODA) rose slightly in 1999 to 0.1 percent of GNP, but remains near its recent historical low level. Under the FY 2001 Budget, ODA would remain at this low level over the five-year budget horizon. The IMF staff urges the authorities to make further efforts to raise foreign assistance.
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