WEO argues for early consolidation of the U.S. fiscal deficit

• Pages: 140-142

Page 140

Between 1992 and 2000, the U.S. economy grew rapidly, propelling the global economy. From mid-2000, however, the economy weakened significantly following one of the largest stock market declines in the postwar period, the terrorist attacks of 9/11, major corporate failures, and the war in Iraq. Active fiscal policies by the federal government to help restart the U.S. economy, together with spending linked to the war on terror and a cyclical move from high to low growth, have resulted in a 7 percentage point deterioration in the U.S. budget deficit, as a ratio to GDP, in fiscal year 2004 relative to the fiscal year 2000

How worrisome is the budget outlook? Until now, the fiscal stimulus has had a positive impact on output in both the United States and the rest of the world as Americans have imported more without putting significant pressure on long-term interest rates. The U.S. fiscal expansion has thus provided important support for global demand at a time when monetary policies-particularly in the United States and Japan- were already stretched, with little or no further scope for cuts in short-term rates. However, there is growing concern about the medium-term effects of the fiscal expansion, including its potential implications for global interest rates, productivity, and income-not to mention the value of the dollar. These concerns have come to the fore with expectations that monetary policy will soon return to a more neutral stance, and as investment revives and the U.S. current account deficit reaches record-high levels.

From a historical perspective, the speed of the widening of the fiscal deficit has few parallels. The budget turnaround from fiscal year 2000 to 2004 as a ratio to GDP is the fastest of the past 50 years. In contrast, the current federal deficit is large but not unprecedented as a ratio to GDP: the projected deficit in fiscal year 2004 is similar in magnitude to deficits seen in the mid-1980s.

The administration projects that the deficit will decline to roughly half its 2004 level in the next five years. This decline is predicated on a series of assumptions that include buoyant tax revenues from strong economic growth, no reform of the Alternative Minimum Tax (AMT)-a parallel income tax system for higher-income taxpayers with fewer exemptions and deductions...