Public Information Notice No. 00/52

Public Information Notice: IMF Concludes Article IV Consultation with the United States

July 28, 2000

On July 21, 2000, the Executive Board concluded the Article IV consultation with the United States.¹

Background

Economic activity continued briskly in 1999 and through mid-2000, as the current expansion entered its 112^th month in July 2000, the longest U.S. economic expansion on record. Real GDP grew by 4¼ percent in 1999, surging to a 6½ percent annual rate in the second half of the year, and slowing only slightly in the first quarter of 2000 to an annual rate of 5½ percent. Continued momentum in private consumption and investment remained the primary sources of strength, as growth in final demand remained at 5½ percent in 1999 and rose to an 8 percent annual rate in the first quarter of 2000. Labor market conditions remained very tight with the unemployment rate around 4 percent in June 2000. Core inflation has been largely subdued owing in part to gains in labor productivity and weakness in non-oil import prices. Data for the early months of 2000 raised some concerns that price and wage pressures were beginning to emerge, but more recent data provide a more ambiguous picture. The core consumer price index (the CPI excluding food and energy prices) increased by 2 percent in 1999 and in early 2000. After rising sharply in March, core inflation settled back down to 2 percent annual rate during the second quarter of 2000.

By mid-1999, concerns about domestic demand growth in excess of the growth in potential output and further tightening in labor markets prompted the Federal Open Market Committee (FOMC) to tighten monetary policy. Over the period June 1999 to May 2000, the FOMC raised the federal funds rate by 175 basis points, including increases at four consecutive FOMC meetings, culminating in a 50 basis point increase in May. At its June meeting, the FOMC decided to leave the federal funds rate unchanged, but in its announcement following the meeting, the FOMC indicated that the risks continued to be weighted mainly toward conditions that may generate heightened inflationary pressures in the foreseeable future.

The unified federal budget balance moved into surplus in FY1998 (¾ percent of GDP) for the first time since FY 1969, and the surplus is expected to reach 2¼ percent of GDP in FY 2000. Expenditure cuts and tax increases adopted as part of the Omnibus Budget and Reconciliation Act of 1993 have accounted for the steady improvement in the fiscal balance since 1992. In addition, policy actions contained in the Balanced Budget Agreement of 1997 helped to ensure a further improvement in the unified budget balance.

In real effective terms, the dollar appreciated by 3½ percent in 1999 and by a further 7½ percent in the first five months of 2000. A 12¼ percent depreciation against the yen during 1999 was more than offset by a 14½ percent appreciation of the dollar against the euro. In the first five months of 2000, the dollar appreciated modestly against the yen, but more sharply against the euro. In real effective terms, the dollar in May 2000 was 39 percent higher than its low in April-July 1995. The external current account deficit widened to about 3½ percent of GDP in 1999 from 2½ percent in 1998, largely owing to a further increase in the merchandise trade deficit, as import volume growth more than offset a pick-up in export volume growth that was driven by economic recovery in partner countries in the second half of 1999.

Executive Board Assessment

Executive Directors commended the authorities for their sound monetary and fiscal policies, which have contributed to making the current U.S. economic expansion the longest on record. Measures to improve the fiscal stance, together with the strength and duration of the current expansion, have resulted in a steady improvement in the federal fiscal balance since 1992. The outlook for sustained budget surpluses over the longer term holds out the prospect of eliminating the net federal government debt held by the public early in the next decade, an eventuality that Directors strongly supported in view of the longer-term fiscal pressures associated with the aging of the population. They noted that monetary policy has helped to sustain the expansion, which had provided significant support to the global recovery that appears to be well under way, while keeping U.S. inflation low.

Directors agreed that the remarkable strength of U.S. domestic demand growth has been supported by rising real incomes, enhanced profitability in the corporate sector, and rapidly growing household wealth-all closely related to the surge in productivity experienced in the United States in the second half of the 1990s. This productivity surge also had been a primary factor underlying the attractive investment environment in the United States, which has drawn in substantial flows of capital, contributing to a sharp widening of the current account deficit, against the background of historically low personal savings rates. Directors considered that the sustainability of current high stock market valuations will depend to a considerable extent on the duration of the factors underlying the surge in productivity growth, and thus the outlook for corporate earnings. At this juncture, while Directors recognized that judgment on how long this process might continue to support high levels of productivity growth—with their associated favorable effects on real incomes, profits, and wealth—is difficult, they agreed that continued domestic demand growth at a pace well in excess of the productivity-driven increases in potential output is not sustainable, and needs to be slowed.

Directors agreed that the principal policy priority for the United States in the near term is to ensure that the pace of aggregate demand growth is brought back in line with the economy's potential growth in supply in order to keep inflation in check and the economic expansion on track. They strongly supported the policy actions of the Federal Reserve over the last year to slow the pace of demand growth. Most Directors considered that a further tightening of monetary policy could be required to ensure that inflation remains under control. However, Directors generally agreed that the need for further action to raise rates will depend on how the economy responds in the period immediately ahead to the restraining effects of monetary policy actions already in the pipeline, and if any additional indications of wage and price pressures emerge. Directors noted that, while monetary policy tightening in the United States has inevitable potentially adverse spillover effects on the rest of the world, the impact would be even more detrimental if the U.S. authorities unduly delay policy action, and subsequently tighten monetary policy more sharply once inflationary pressures strengthen.

Directors considered that fiscal policy will have an important role to play in restraining domestic demand growth in the near term, and supported the Administration's intention to preserve a substantial share of the fiscal surpluses in prospect. They emphasized the importance of resisting pressures to substantially cut taxes or raise spending, as these would add to demand pressures at an inappropriate time and thereby jeopardize the continued noninflationary expansion of the economy. Directors noted that maintaining a tight fiscal position would help raise the level of national savings, ensuring an orderly correction in the current account imbalance over the medium term and enabling the economy to sustain a continued high rate of investment.

From a longer-term perspective, the elimination of the net public debt will be an important step toward preparing the federal government for the coming long wave of unfunded liabilities associated with the aging of the population. Many Directors considered that a reasonable medium-term fiscal policy objective is to eliminate the actuarial imbalances facing Social Security and Medicare Hospital Insurance (HI), and then aim at keeping the remainder of the budget roughly in balance on average over the business cycle. This objective might be facilitated if revenues and expenditures of Social Security and Medicare HI were more formally separated from the rest of the federal budget, in order to help mitigate pressures to divert surpluses in these programs to other uses. These Directors noted that the U.S. authorities are moving in this direction, having already placed Social Security off-budget and the Administration recommending to do the same with Medicare HI. Directors also suggested that continued fiscal discipline would be facilitated by extending discretionary spending caps and the PAYGO financing requirement through fiscal year 2010.

Several Directors noted that, with government debt being retired, the prospective disappearance of a risk-free benchmark could have potentially significant implications for international reserve management of other countries. They suggested that the staff further study the policy implications for the U.S. and for the world economy.

Directors supported the Administration's intention to address the longer-term imbalances facing Social Security and Medicare HI, but some Directors questioned whether transferring general budgetary resources to these programs would be sufficient to address the imbalances. These Directors noted that under current estimates, relatively small adjustments in the parameters of both the Social Security and Medicare systems, if put in place soon, would be sufficient to meet the future liabilities of the programs. A few other Directors, however, cautioned that, under the present fiscal environment, increasing the regressive payroll tax may not be desirable, particularly on equity grounds. Resort to general revenues, on the other hand, could potentially erode an important budget constraint that had helped over the years to restrain spending on benefits. A number of Directors considered that supporting these programs with general revenue risks opening the door to subsequent on-budget transfers to finance further extensions of benefits.

Directors noted that the Administration continues its practice of proposing small targeted tax cuts to promote specific economic and social objectives. While recognizing that well-targeted tax credits may prove beneficial in a number of cases, they cautioned that overreliance on such tax expenditures adds to the complexity of the tax code, undermining transparency and increasing compliance costs. Directors encouraged the authorities to refrain from seeking measures that risk eroding the efficiency of the income tax system, especially when the underlying objectives are amenable to being addressed effectively through spending programs.

Directors congratulated the U.S. authorities on the adoption of the Gramm-Leach-Bliley Act, which represents a much needed overhaul of the outdated laws regulating the financial sector in the United States. The new regulatory supervisory structure and the expanded opportunities available under the law for new financial holding companies to engage in banking, securities, and insurance activities and the new regulatory supervisory structure pose significant new challenges. Among these is the central supervisory challenge to ensure that emerging larger, more complex financial institutions adopt sufficiently robust risk-management systems. Directors welcomed the authorities' intention to make more use of market information and discipline in supervising financial institutions. A few Directors encouraged the authorities to consider the preparation of a ROSC module on consolidated supervision.

Although Directors did not see any major vulnerabilities in the banking sector, they noted the high levels of household and corporate debt, and they agreed that any substantial downturn in the economy would inevitably produce some financial distress, with falling incomes and profits creating debt-servicing difficulties for some households and businesses. In this context, they strongly supported the authorities' efforts to pre-emptively limit the scope of such potential future financial distress by cautioning bank lending officers against loosening lending standards and basing loan decisions on tenuous extrapolations of the current favorable economic conditions.

Directors observed that, as a general rule, the Administration has supported and promoted enhanced market competition throughout the economy. In this context, they commended the authorities for the improvements in market access provided by the recently enacted African Growth and Opportunity Act and the Caribbean Basin Initiative. Noting the increase in antidumping (AD) and countervailing duty (CVD) actions in the past two years, many Directors suggested that the authorities consider changing the administration of AD/CVD procedures in a way that makes import protection available only in those cases where foreign producers are found to be engaged in anticompetitive behavior.

Directors expressed concern about the low level of U.S. official development assistance as a ratio of GNP, and urged the authorities to strengthen their commitment in this area. They welcomed the Administration's support for the enhanced HIPC Initiative, and encouraged the U.S. government to complete the necessary financing arrangements.

Directors noted that the quality, coverage, periodicity, and timeliness of U.S. economic data are considered to be excellent both in the context of the Article IV consultation and for purposes of ongoing surveillance.