History repeats itself. The U.S. Treasury has reached the authorized debt limit and the parties are negotiating a solution against the clock. The uncertainty and the specter of a possible default generates instability in the market and weighs on the economy. The International Monetary Fund (IMF) has called this Friday in Washington for an immediate solution to the pressing problem, but also a permanent remedy so that the debt crisis does not recur on a recurring basis.
After meeting with the Secretary of the Treasury, Janet Yellen, and with the chairman of the Federal Reserve, Jerome Powell, the managing director of the IMF, Kristalina Georgieva, has insisted on the need to find a solution in the press conference in which she has presented the conclusions on her annual analysis of the US economy.
"Reaching a good result is paramount from a global perspective. We think of U.S. Treasury debt as an anchor for the global financial system. And this anchor needs to be kept solid. So at a time of significant uncertainty, let's not add a self-inflicted wound to those already suffering from the global economy. There is some encouraging news that discussions are advancing. But the world is watching and the world is saying, 'Okay, we're going to shut this down. And please, can you come up with a different way of approaching this issue?" said Georgieva.
According to the Fund, tensions over the federal debt ceiling could create an additional, entirely avoidable systemic risk for both the US and global economies, at a time when visible tensions already exist. To avoid exacerbating downside risks, Congress should immediately raise or suspend the debt ceiling, allowing negotiations on the fiscal year 2024 budget to begin in earnest, the agency says.
"In addition, a more permanent solution to this recurring confrontation should be found through institutional changes that ensure that, once the credits are approved, the corresponding space in the debt ceiling is automatically provided to finance that expenditure," the IMF said in its statement of conclusions.
The IMF has raised the growth forecast of the United States for this year by one tenth, to 1.7% and lowered next year's growth forecast by one tenth, to 1%, compared to April's forecasts. Its experts highlight that the economy has shown its resilience in the face of the significant tightening of fiscal and monetary policy that took place in 2022 and has avoided recession so far. Consumer demand has held up particularly well, driven initially by the contraction of pent-up savings and, more recently, by solid growth in real disposable income thanks to job creation and wage increases.
The crux of the coin is that inflation is reluctant to budge and will remain "substantially above" the 2% target this year and next, the IMF estimates. "A prolonged period of tight monetary policy will be necessary for inflation to return firmly to target, with the federal funds rate remaining at 5.25%-5.5% until the end of 2024." They are higher interest rates for longer than the market expects today.
The Fund warns that the broad and rapid rise in interest rates already under way may not be sufficient to quickly return inflation to target. "With a large share of household and corporate debt contracted at relatively long maturities and fixed rates, household consumption and business investment have proven to be less sensitive to interest rates than in previous tightening cycles," the IMF explains.
Risk of recession
This creates a significant risk that the Federal Reserve will have to raise the policy rate much more than is currently expected to return inflation to 2%. The IMF believes that some surprises of higher-than-expected growth are possible in the short term, but with contraindications: "This would only mean that the economy would slow more sharply at a later stage (possibly in 2024), creating a recession as tighter monetary policy takes hold. The combination of higher U.S. interest rates, a stronger dollar, and a sharper slowdown in U.S. activity would have significant negative repercussions on the rest of the world."
In addition, a more aggressive rise in interest rates could reveal more serious and systemic problems than those observed to date in the balance sheets of banks, non-banks or companies, according to the agency, which believes that the consequent "tightening of financial conditions could trigger an increase in bankruptcies, worsen credit quality and increase stress on those entities with high levels of leverage and large gross needs of short-term financing."
The IMF warns that the United States needs a fiscal adjustment to make its debt sustainable, of no less than 5 points of GDP. The IMF believes that such an adjustment will be impossible if families earning less than $400,000 a year are to be kept out of tax increases and no changes are made to Social Security and Medicare.
There are recipes to reduce the deficit through collection and the Fund leaves a wide menu of proposals. "Revenues could be increased through a broad-based federal consumption tax, a carbon tax, higher taxation of high-income businesses and individuals, reduction of misdirected tax expenditures (such as those related to employer-provided health care, sale of primary residence, mortgage interest and state and local taxes), closing tax loopholes, lowering the minimum threshold for wealth tax, and further improving revenue management," it says in its conclusions.
And there are also proposals on Social Security and health care: Social Security benefits could be indexed to somewhat more moderate inflation measures than the headline CPI such as the chained CPI, the income ceiling for Social Security contributions could be raised, and increases in the retirement age could accelerate. Health costs could be reduced through greater cost-sharing with beneficiaries and changes in the remuneration mechanisms of healthcare providers.
Finally, the IMF encourages the United States to make more efforts in the fight against climate change and criticizes the protectionist economic policy it is carrying out with its aid: "The Inflation Reduction Act, the CHIPS Act and the Build America, Buy America Act have provisions explicitly designed to favor goods and services produced in the United States or North America. While these measures aim to increase the security and resilience of supply chains, these protectionist provisions distort trade and investment and risk creating a slippery slope that fragments global supply chains and triggers retaliatory measures by trading partners," the Fund says.
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