The IMF cut its US growth forecast for next year to 2.7 percent on Friday, saying the economy is being held back by “excessively rapid and ill-designed” government spending cuts.
The severe sequester cuts, aimed at closing the US deficit, are already taking up to 1.75 percentage points from this year’s growth potential.
Even though growth is to pick up pace next year, it will still be less than the 3 percent the IMF previously forecast, due to the impact of the sequester, which requires US$109 billion to be sliced from spending in the coming fiscal year.
In its annual report on the US, the IMF called on the US Congress to repeal the sequester, saying that stronger growth in the short term is important both for the US and global economies.
“The automatic spending cuts not only exert a heavy toll on growth in the short term, but the indiscriminate reductions in education, science and infrastructure spending could also reduce medium-term potential growth,” the IMF said.
The sequester cuts for this year have had one beneficial outcome — cutting the fiscal deficit by a huge 2.5 percent, the IMF said.
However, that is likely too much in a short period.
“The deficit reduction in 2013 has been excessively rapid and ill-designed,” the IMF said. “A slower pace of deficit reduction would help the recovery at a time when monetary policy has limited room to support it further.”
Despite encouraging a looser fiscal stance now and despite the narrowing of the fiscal gap, the IMF still warned that Washington needs to do more to address its longer-term fiscal imbalances.
With the economy picking up, gross US government debt was projected to peak at 110 percent of gross domestic product in 2015 and then start to decline.
“But the longer-term debt profile remains unsustainable,” the report said.
“Despite the slowdown in growth rates over the past few years, spending on major healthcare programs and social security, absent additional reforms, is expected to increase by 2 percentage points over the next decade,” it added.
That will cause the deficit to begin widening and start pushing the debt ratio back up.
It suggested fundamental tax reforms as part of actions to confront the longer-term fiscal shortfall, including eliminating many exemptions and loopholes, and introducing a value-added tax and a carbon tax.
The IMF held its growth forecast for this year at 1.9 percent, saying the pickup will only really start toward the end of the year.
It credited the Federal Reserve’s aggressive quantitative easing — its US$85 billion-a-month bond purchases, to hold down interest rates — with keeping the economy on a sure footing as the government slashes spending.
Lagarde said the Fed program merited holding in place through this year, adding that the US’ central bank was still not close to targets on reducing unemployment and on inflation to rein in the quantitave easing purchases.
“We believe that the monetary policy has been necessary and helpful,” she told a news conference.
When, further down the road — the IMF predicts early next year — the Fed begins reducing its bond purchases and holdings to tighten policy, Lagarde urged extreme care in designing and communicating how it does that.
“The unwinding, when it comes, should be very carefully managed,” she said.