U.S. economic recovery stronger than expected, public debt as major challenge

08:12, July 09, 2010      

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The International Monetary Fund (IMF) said on Thursday that the U.S. economic recovery has proved stronger than earlier expected due to massive macroeconomic stimulus, but huge public debt might drag the recovery out of track if not properly addressed.


The U.S. economy is expected to grow 3.3 percent in 2010 and 2. 9 percent in 2011, the IMF said in its latest assessment of the U. S. economic growth prospect.

This represented an upward revision from the agency's previous assessment. In its World Economic Outlook report issued in April, the IMF expected the U.S. economy to grow 3.1 percent in 2010 and 2.6 percent in 2011.

"While still modest by historical standards, the recovery has proved stronger than we had earlier expected, owing much to the authorities' strong and effective macroeconomic response, as well as the substantial progress made in stabilizing the financial system."

The IMF seemed to be less optimistic about the country's employment situation compared with its assessment of the overall economy. It expected the U.S. unemployment rate to remain high, averaging 9.7 percent in 2010 and slightly going down to 9.2 percent in 2011.

The U.S. unemployment rate dropped to 9.5 percent in June, the lowest level in almost a year, but it merely reflected fewer people looking for jobs. Meanwhile, employers cut 125,000 jobs last month, the first of new job decline in six months.

The report downplayed the risk of inflation, expecting consumer prices to rise a moderate 1.6 percent this year and an even lower 1.1 percent for the next.

The IMF warned of a host of challenges the U.S. economy is facing, including a possible double dip in housing market caused by "the backlog of foreclosures and high levels of negative equity, combined with elevated unemployment;" the continued deterioration in commercial real estate market; and still-tight financing conditions, especially for smaller firms reliant on bank finance.

In addition, the IMF said the sovereign debt crisis in European countries may pose as another challenge to the U.S. economy, " potentially impacting the United States through financial market and, in a tail risk scenario, trade links."


"On the macroeconomic side, the central challenge is to develop a credible fiscal strategy to ensure that public debt is put -- and is seen to be put -- on a sustainable path without putting the recovery in jeopardy," the IMF said.

According the IMF statistics, the U.S. public debt has almost doubled since 2007, to a current level of 64 percent of GDP, the highest since 1950.

The report warned that under current policies, the U.S. public debt could reach 95 percent of GDP by 2020, and could rise further to over 135 percent of GDP by 2030, considering the impact of the aging population and rising health care costs.

The Obama administration expected the federal budget deficit to set a new record at 1.5 trillion dollars this year. It vowed to work to halve the budget deficit by 2013, and stabilize public debt at just over 70 percent of GDP by 2015.

The IMF welcomed these commitments, but emphasized that "much remains to be done to achieve these aims."

The report suggested that the U.S. government should both reduce expenditure and increase revenues. Specific measures suggested in the report include further base broadening via cuts in deductions, particularly for mortgage interest; higher taxes on energy; a national consumption tax; or a financial activities tax.

In the meantime, the IMF stressed that "the timing and composition of the adjustment will need to be carefully designed to minimize the impact on demand while ensuring credibility."


The report gave a high score to the Federal Reserve for its handling of monetary policy, saying it "has deftly managed the tradeoff between near-term support and medium-term credibility."

"It has appropriately maintained an extraordinarily low level of policy rates and signaled its intention to maintain them for an extended period, supporting economic and financial stability," said the report. "And at the same time, it has wound down almost all of its emergency facilities and ended a very substantive asset purchase program, with very little adverse impact on markets, aided by careful and effective communication."

The fed has maintained the federal fund rate unchanged at a record low of between zero to 0.25 percent since the end of 2008 to prop up the economy, and said the rate is likely to remain at the current low level for "an extended period."

"For the near term, with inflation very low, we believe that maintaining the present high level of accommodation is appropriate to hedge deflation risks and help to counteract the forthcoming fiscal drag on economic activity, while also supporting financial conditions," said the report.

The IMF also said that considerable progress has been made in restoring financial stability, but important risks remain.

"Important parts of the banking system remain vulnerable to shocks," it noted. "It will be important that banks adequately recognize the risks on their balance sheets, and have sufficient capital to support the ongoing recovery."



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