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IMF Warns US Again Over 'Fiscal Cliff'

by Mike Godfrey,, Washington

18 July 2012

In its latest Global Financial Stability Report, the International Monetary Fund (IMF) points to uncertainties on the fiscal outlook and federal debt ceiling in the United States as presenting a latent risk to its financial stability.

It considers that, if no policy action is taken, the US ‘fiscal cliff’ - the convergence of expiring tax cuts and automatic spending reductions at the beginning of 2013 - could result in a fiscal tightening equivalent to more than 4% of gross domestic product (GDP).

As the year-end approaches and uncertainty increases, the IMF fears that another bout of political brinksmanship - similar to that seen in August 2011 in discussions on the US debt ceiling – could trigger increased market volatility, particularly as the debt ceiling could be hit again around the same time as the fiscal cliff.

While the financial markets expect that the bulk of fiscal tightening will be deferred until later and that the debt ceiling will be raised in time to avert a default, the IMF says that there remains the potential for a significant adverse market reaction should market participants reassess the likelihood of a fiscal cliff, given its potentially severe effects on the US economy.

In addition, the lack of progress on a credible fiscal consolidation plan risks triggering additional US sovereign credit rating downgrades, leading to a loss in liquidity and a destabilizing impact on broader financial markets.

In its Fiscal Monitor Update, issued contemporaneously with the Global Financial Stability Report, the IMF reiterates its concern over the US fiscal outlook for next year, and looks for a more modest retrenchment in 2013 - of around 1%, rather than 4%, of GDP - as a better option.

The IMF has earlier seen the US government’s main challenge as how to support the recovery in the near-term, while restoring fiscal sustainability, through a balanced approach to medium-term consolidation. A contraction of the government’s primary deficit of around 1% of GDP should go together with an early agreement on a comprehensive set of measures to stabilize the public debt ratio by mid-decade, it said.

Given the size of the US budget deficit, age-related spending pressures, and the relatively low tax ratio, the IMF has previously suggested that the medium-term consolidation effort will need to rely both on higher revenues and reforms to slow the growth of entitlement spending.

TAGS: tax | economics | fiscal policy | gross domestic product (GDP) | International Monetary Fund (IMF) | United States

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