The United States will continue to notch modest growth of around 2 percent growth this year and next but must avoid a year-end 'fiscal cliff' of tax hikes and spending cuts that would tip it back into recession, the IMF said on Monday.
In a semi-annual checkup on the health of the world economy, the International Monetary Fund also said Canada would grow by roughly the same rate as its southern neighbor, and must take care to ensure that its housing boom does not turn into a bust.
A resumption of the euro zone debt crisis is a risk for both countries but would be a harder hit on the United States, a major European trading partner, dampening demand for U.S. goods and pushing up the dollar to make U.S. exports more expensive.
However, the crucial threat to the continued recovery of the U.S. economy is home grown, the IMF said in its October World Economic Outlook.
"In the United States, it is imperative to avoid excessive fiscal consolidation (the fiscal cliff) in 2013, to raise the debt ceiling promptly, and to agree on a credible medium-term fiscal consolidation plan," it urged. The IMF calculated the full impact of the tax hikes and spending cuts would withdraw more than 4 percent from U.S. gross domestic product in 2013.
Tax cuts approved during the administration of former President George W. Bush are set to expire at the end of this year, and deep automatic reductions to government spending are scheduled to start kicking in, unless Congress agrees to a massive debt and deficit reduction deal.
No hope is given for a compromise before the November 6 general election between President Barack Obama's Democrats, who hold sway in the Senate, and their Republican foes, who currently control the U.S. House of Representatives. But failure to do a deal would have dramatic negative consequences.
"Growth would stall in 2013 with the full materialization of the cliff and ... would inflict large spillovers on major U.S. trading partners and also on commodity exporters (because of declines in commodity prices)," the IMF said.
The lackluster U.S. economic performance is a "legacy" of the collapse of the country's housing market and ensuing recession between 2007 and 2009, the IMF said, echoing a claim Obama makes frequently as he campaigns against his Republican presidential challenger Mitt Romney.
But the IMF also pointed out that official policies have failed to sufficiently tackle the challenge posed by the heavy overhang of foreclosed properties.
"In the housing market, more must be done to reduce the rate of foreclosures and remove impediments to the transmission of low long-term policy rates to mortgage rates," the Fund said.
IMF BACKS FED
With U.S. politicians locked in a bitter election campaign, in which the White House, all the seats in the House and one third of those in the Senate are up for grabs, there has been little likelihood of fiscal policy action to spur growth.
The Federal Reserve, however, did decide to act, announcing a third round of so-called quantitative easing in September, under which is promised to buy $40 billion of mortgage backed bonds every month until labor market conditions improved.
This provoked Republican criticism that the U.S. central bank was risking inflation and interfering in the political process through action that, by helping the economy, would favor Obama for a second term. But the IMF backed the Fed decision.
"The recent measures by the Federal Reserve on additional quantitative easing and the extension of its low-interest-rate guidance until mid-2015 were timely in limiting downside risks. Monetary policy needs to remain accommodative while the government and household sectors continue to consolidate."
CANADA RECOVERY MORE ROBUST
The WEO also focused on Canada, which the IMF viewed as enjoying a more robust recovery than the United States, thanks in part to "exceptionally favorable financing conditions", but voiced concern at a resulting rise in household leverage.
"In Canada, the key priority is to ensure that risks from the housing sector and increases in household debt remain well contained and do not create financial sector vulnerabilities," the IMF said. "If household leverage continues to rise, additional measures may need to be considered."