Yahoo News IMF urges Biden administration to cut spending, help Fed bring down inflation
The IMF is recommending the Biden administration rein in spending to better balance the United States' debt load and help the Federal Reserve's efforts to tamp down inflation.
"It seems clear to me that from the viewpoint of medium and long-term prospects, there is a very strong case for fiscal adjustment in the US," Vitor Gaspar, Director of the IMF's Fiscal Affairs Department, told Yahoo Finance in an interview.
"It also seems opportune as a way of helping the Fed in the fight against inflation, thereby moderating necessary increases in interest rates."
Inflation has proven to be more persistent over than many economists had expected over the last two years, with the latest Consumer Price Index showing prices excluding volatile food and energy categories rose 5.6% over last year in March.
Over the past year, the Fed has embarked on its fastest rate-hiking campaign since the late 1980s, raising its benchmark interest rate 4.75 percentage points. The fed funds rate now stands in a range of 4.75%-5%, the highest level since 2007. Investors expect the Fed to raise rates another 0.25% next month.
At the same time, the US government's debt load projected to increase exceed the peak of the pandemic by 2027. The IMF estimates the US debt as a percentage of GDP will stand at 135% in 2028 with the deficit projected at 6.8% — both significantly outpacing other advanced economies.
In his first two years in office, President Biden approved nearly $2 trillion in new spending. The president signed a more than $1 trillion bipartisan infrastructure bill into law that put new funds into roads, bridges, transportation, broadband, and utilities in 2021. Last year, Biden also signed a sweeping $750 billion health care, tax, and climate bill dubbed the Inflation Reduction Act.
The president has proposed a nearly $7 trillion budget for 2024 that calls for reducing deficits by around $3 trillion over the next decade by raising taxes on wealthy individuals and large corporations.
"We believe that fiscal tightening by moderating aggregate demand makes it easier for central banks to deliver inflation at target in a timely way in the sense that the required increase in policy rates is less," Gaspar said.
Without the US, advanced economies would actually have a declining public debt to GDP ratio over the medium term, according to Gaspar. As rates rise, higher debt levels also means servicing higher interest costs on that debt.
Gaspar argues moderating interest rate increases also helps with financial stability because rate hikes can cause fragilities in the financial system, as seen by recent bank failures in the US.
Aside from helping monetary policy and staving off shocks to the economy, the IMF argues government spending cuts would help rebuild fiscal coffers that were used to respond to COVID and other economic shocks in recent years. The IMF also argues exercising fiscal restraint frees up cash to fight against climate change.
One of the "fiscal cliffs" facing the US is raising the nation's borrowing limit in a timely fashion. Gaspar says waiting until the last minute to raise the debt ceiling creates unnecessary uncertainty and volatility, which creates issues for not just the US but the global economy.
"Anything that can be done to minimize uncertainty and volatility and that would include a quick resolution of this political process around the debt ceiling would be welcome in the past," argues Gaspar.
House Republicans are demanding spending cuts in exchange for raising the nation's borrowing limit, but the White House has said it won't negotiate on paying for what the government already agreed to spend.
House Speaker Kevin McCarthy is reportedly planning to propose a plan next week that would suspend the debt ceiling for a year in return for a party wish list of spending cuts and regulations. While it has little chance of being enacted, it could serve as the opening overture for future budget talks.
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