The International Monetary Fund cut its outlook for U.S. economic expansion this year, citing a weak energy sector, a strong dollar and turmoil overseas.
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The IMF said Wednesday that it now expects the American economy to grow 2.2% this year, down from its 2.4% forecast in April and slower than last year's pace. Although the fund kept its forecast for a pickup in 2017 at 2.5%, it said recent weak data means the Federal Reserve should stay its hand on interest rates for a while.
"There is a clear case to proceed along a very gradual upward path for the Fed funds rate," the IMF said in its annual review of the U.S.
The Fed first must ensure wage and price inflation are rising and remain on guard against globally anemic price inflation, the fund said. Also, IMF economists said a strong dollar could remain a problem for the U.S., particularly with the threat of further economic turmoil overseas, and a slowdown in corporate investment could continue to weigh on growth in the coming quarters.
Last week, the Fed held rates steady and officials lowered projections for how fast the central bank expects to raise them, concerned about persistently slow growth.
The IMF said that given weak output and inflation risks, the Fed should plan on temporarily overshooting its medium-term inflation target of 2% as insurance against having to reverse course and push rates back down to zero.
Still, the fund warned that recent data showing weak activity in the U.S. economy might indicate the capacity for the U.S. to expand is much lower than previously thought. Less slack in the U.S. economy could see inflation surge, requiring the Fed to quickly raise rates despite tepid U.S. growth. Such a scenario could harm already-fragile growth globally as the world's most important central bank raised borrowing costs and curbed U.S. expansion.
The IMF also warned that the U.S. faces potentially significant longer-term challenges to strong and sustained growth. "Concerted policy actions are warranted, sooner rather than later," the IMF said. The ability of the U.S. to expand has fallen from above 3% in the early 2000s to below 2% now.
Declining labor-force participation, falling productivity growth, a widening income gap and high levels of poverty risks further constrain the ability of the U.S. to expand, the fund said.
If left unchecked, those dynamics "will corrode the underpinnings of growth...and hold back gains in U.S. living standards," Christine Lagarde, the fund's managing director, said.
To raise future U.S. growth prospects, the IMF urged Washington to overhaul the tax code, including for corporations and expanding credits for lower-income brackets. The government also should boost public investment in a crumbling infrastructure system and revamp costly entitlement programs, the fund said.
Those efforts are also necessary to cut America's growing debt problem. The IMF expects federal debt will begin rising in 2019 and exceed 80% of gross domestic product by 2022.
Amid rising antitrade rhetoric in the U.S. presidential race, the IMF also warned against the U.S. economically isolating itself. "Resisting all forms of protectionism will also be essential," the fund said.
Both presidential contenders Donald Trump and Hillary Clinton have come out against the Trans-Pacific Partnership trade deal, essentially nixing the odds of getting President Barack Obama's signature trade agreement ratified in Congress anytime soon.