Ease Off Spending Cuts to Boost U.S. Recovery

U.S growth expected to slow to 1.9 percent in 2013, but could pick up in 2014

Recovery hinges on more balanced, gradual pace of fiscal adjustment

Exit from monetary policy stimulus requires careful communication, timing

“There are signs that the U.S. recovery is gaining ground and becoming more durable. However, it has a way to go before returning to full strength. The IMF’s advice is to slow down, but hurry up: meaning slow the fiscal adjustment this year—which would help sustain growth and job creation—but hurry up with putting in place a medium-term road map to restore long-run fiscal sustainability,” Managing Director Christine Lagarde said.

Despite some improvements in economic indicators, particularly in the housing market, the very rapid pace of deficit reduction (including automatic spending cuts known as the sequester) is slowing growth significantly, the IMF said.

U.S growth is expected to slow to 1.9 percent in 2013, from 2.2 percent in 2012. This projection reflects the impact of the sequester, and the expiration of the payroll tax cut and the increase in tax rates for high-income taxpayers.

Growth could pick up to 2.7 percent next year with a more moderate fiscal adjustment and a further strengthening of the housing market, the IMF said.

Strengthening the recovery

According to the IMF, the main policy challenge is to support the recovery, while addressing the vulnerabilities that threaten growth, public finances, and financial stability in the medium term.

In its assessment, the IMF emphasized a fiscal policy strategy to deal with this challenge, including the need to:

• Repeal the sequester and adopt a more balanced and gradual pace of fiscal consolidation. The spending cuts not only reduce growth in the short term, but the arbitrary reductions in education, science, and infrastructure spending could also reduce medium-term potential growth.

• Raise the debt ceiling to avoid a severe shock to the United States and the global economy.

• Adopt a comprehensive and back-loaded set of measures to restore long-run fiscal sustainability. Spending on major health care programs and Social Security is expected to increase by 2 percentage points of GDP over the next decade. Interest outlays are also projected to increase by 2 percentage points of GDP over the same period, as interest rates gradually return to normal levels. These factors would again widen the budget deficit and increase public debt. New revenues could be raised...