The IMF's Fiscal Prescription for the US

The IMF just released its experts' assessment of the US economic and fiscal outlook to the public (although it was dated June 21). The report recommends ways in which the US can get itself back on track fiscally, when to do it, and what goals it should set for the medium term.

The US economy's recovery is considered increasingly well-established, due to the massive policy measures undertaken. However, going forward, risks to the economy are seen increasingly on the downside. [Comment:  contrast this to increasing Wall Street optimism in the past week.] The biggest trouble spots seen by the Fund are persistent housing sector and financial sector weakness plus possible negative spillover effects from the Eurozone fiscal crisis.

The economic forecast is less optimistic than the Obama Administration's. The Fund staff expects growth of 2.9% next year and 2.8% in 2012. In contrast, the Administration (early this year) projected 3.8% next year and 4.3% in 2012. The Fund expects unemployment to be about a point higher than the Administration's forecast.

Because of the more pessimistic economic assumptions, the IMF projects debt held by the public to reach 96% of GDP by 2020, about 20 percentage points higher than a comparable forecast by the Administration. The challenge for the US is to put its public debt on a sustainable path without jeopardizing the economic recovery, says the Fund.

Against this backdrop, the Fund supports the Administration's commitment to halve the annual budget deficit by 2013 and to stabilize the debt at 70% of GDP starting in 2015. However, based on its less optimistic economic assumptions and resulting higher debt projections, the IMF sees the necessity of stiffer medium term annual budget goals than those given to the Fiscal Commission. The Fund calls for a primary surplus of 3/4% of GDP by 2015, rather than the primary balance that is the goal of the Commission. In order to accomplish this goal, it estimates that the US should undertake adjustment of 8% of GDP to its underlying fiscal position (ie, excluding business cycle effects), almost 3 percentage points more than the Obama Administration is planning. Suggestions to fill this gap include changes on both the spending and revenue sides, such as cutting into tax deductions, especially the mortagage interest deduction, and tapping the "big three" of new revenue sources: a VAT, a carbon tax, or a financial activities tax (or some combination of the three.)

To offer guidance on how the US can balance its need to come up with credible sustainable fiscal policy (including fiscal policy which is seen as credible) with the need to support demand until the economy is on stronger footing, the IMF discussed the timing and composition of fiscal consolidation. For the near future, it supported upfront fiscal consolidation and noted that the structural adjustment already proposed for 2011 (a budget deficit reduced by 2% of GDP, as compared to 2010) would be appropriate. If measures supporting labor markets are seen to be needed by Congress, they should be limited and undertaken within the proposed budget framework for next year. Or, they can and should be offset over the longer term. The Fund suggests shifting away from unemployment support and more towards hiring credits once unemployment starts to decline more (perhaps by expanding the generosity of the HIRE Act, which already has a hiring credit in place).

The Fund recommends that any fiscal consolidation steps for the next few years should be accompanied by measures affecting the longer run, including putting fiscal goals and/or other measures in legislation, and making changes in US entitlement programs, none of which would weaken demand in the nearer future.

The Fund points out that if a consensus over critical entitlement changes could be reached, then more fiscal of the fiscal adjustment could be back-loaded. If the economy were weaker than expected, for example, it commented that backloading fiscal adjustment would help limit negative effects of nearer term demand. It specifically thinks that Social Security could be addressed, since "the needed policies are well known." As for measures to control health care costs, Fund expert David Robinson believed that the Independent Payment Advisory Board would be very important going forward and the report suggests going after the exclusion for employer-sponsored insurance if the recent health care reform proves to not be enough.

Beyond 2015, the Fund states: "[T]he aim should be to put public debt firmly on a downward path to rebuild the room for fiscal maneuver (especially given the risks from large funding shortfalls in state and local government pension and health schemes)."

So, a tougher medium term goal plus a credible and sustainable plan for the long term is what the IMF is looking for, keeping in mind the near-term weakness of the economy yet the need for fiscal consolidation. Let's see 'em!