On July 22, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United States.¹

Economic activity in the U.S. accelerated in the second half of 2013, but an unusually harsh winter conspired with other factors—including an inventory correction, a still-struggling housing market, and slower external demand—caused momentum to fade in early 2014, leading to a contraction in growth of 2.9 percent in the first quarter.

Over the past few months, however, a broad-based improvement appears to be unfolding as evidenced by stronger employment and industrial production numbers. Looking ahead, activity is projected to accelerate in the remainder of this year to well-above potential (in the 3–3½ percent range), although the drag on growth from the first quarter contraction will not be offset. This means growth for the year as a whole will be a disappointing 1.7 percent. More positively, barring unforeseen shocks, 2015 growth should accelerate to the fastest annual pace since 2005, propelled by strong consumption growth, a declining fiscal drag, a pickup in residential investment, and easy financial conditions.

Risks around this outlook include slowing growth in emerging markets, oil price spikes related to events in Ukraine and Iraq, and earlier-than-expected interest rate rises. However, as confidence in the recovery picks up, nonresidential investment could grow more than expected and labor force participation could bounce back.

Looking at the medium term, potential growth is forecast to average just above 2 percent for the next several years, significantly below the historic average growth rate. This downgrade reflects the effects of an aging population and more modest prospects for productivity growth. This makes it critical for the authorities to take immediate steps to raise productivity, encourage innovation, augment human and physical capital, and increase labor force participation. Moreover, recent growth has not been particularly inclusive, with the latest data pointing to almost 50 million Americans living in poverty (as shown by the Census Bureau’s supplemental poverty measure) and the official poverty rate stuck above 15 percent despite the ongoing recovery. In terms of policy actions, the Federal Reserve has made important and substantive efforts to increase transparency and has adopted an adaptable approach to communication. The recent shift to qualitative forward guidance provides the Fed with greater flexibility but puts an even higher premium on clear and systematic communication to guide expectations. On the fiscal side, following the debt ceiling brinkmanship and the government shutdown in October 2013, the Bipartisan Budget Act and the subsequent raising of the debt ceiling were important steps to reduce fiscal risks. However, the need for a medium-term fiscal adjustment to ensure a downward path for the public debt remains. On the financial side, progress has been achieved on variety of fronts, including implementing the Dodd Frank Act, finalizing the Volcker rule, and designating another systemic important financial institution. In addition, the U.S. recently put in place a rule to require foreign bank organizations over a certain size to incorporate as holding companies, a move that aligns the treatment of foreign and U.S. banks that are operating in the U.S. and eliminates an existing regulatory distortion.

Executive Board Assessment²

Executive Directors broadly agreed with the thrust of the staff appraisal. They welcomed signs of a meaningful economic rebound following a temporary setback in the first quarter of 2014. Directors noted that stronger growth is expected to be underpinned by a continuation of accommodative monetary policy, a substantial reduction in the fiscal drag, and improved labor and housing conditions. At the same time, however, risks and uncertainties continue to weigh on the outlook, including the pace of interest rate increases and market expectations, and growth prospects in other advanced and emerging market economies. Directors underscored that higher growth in, and strong policy action by, the United States would have important positive global spillovers.

Directors supported focusing policy efforts on managing monetary policy normalization, raising potential growth, reducing long-term unemployment, tackling poverty, and maintaining debt sustainability over the medium term. Achieving these objectives would call for wide-ranging measures—and, more importantly, political consensus—in such areas as investments in infrastructure and education, a comprehensive tax reform, active labor market policies, and a skills-based approach to immigration reform. Directors concurred that an expansion of the Earned Income Tax Credit, possibly complemented by a higher minimum wage, would help address poverty and inequality while promoting labor participation.

Directors welcomed the Bipartisan Budget Act and the subsequent raising of the debt ceiling as important steps to address fiscal risks. They emphasized the critical importance of reaching agreement on a credible medium-term fiscal consolidation plan, which would help to articulate a roadmap for achieving debt sustainability and provide an important anchor for fiscal policy to support the recovery in the short run. In this regard, while a few Directors stressed the need to stay the course of fiscal consolidation, most saw scope for expanding the near-term budget envelope in areas with a high and lasting growth impact, which would need to be funded by savings in future years, including through upfront action to control health care and entitlement spending. Directors also encouraged steps to improve budget procedures and the institutional framework more broadly, with a view to reducing uncertainty in the future.

Directors agreed that the current highly accommodative stance of monetary policy is appropriate, consistent with the Federal Reserve’s objectives of maximum employment and price stability. They generally viewed that, in the case of a slow progression toward full employment and continued subdued inflation, policy rates could stay at zero for longer than currently anticipated so long as inflation expectations remain firmly anchored. Directors recommended, however, that the authorities monitor wage developments closely and remain cognizant of financial stability risks. They welcomed the Federal Reserve’s forward guidance and recommended continued efforts to enhance its communications to provide greater clarity about monetary policy decisions, ensuring a smooth normalization.

Directors welcomed progress in strengthening the resilience of the financial system over the past few years. They called for continued vigilance to potential systemic risks associated with the prolonged period of very low interest rates, particularly activities of nonbank intermediaries. Directors underscored the benefits of a strong macroprudential framework, and tightened supervision and prudential norms across banks and nonbanks, with a few suggesting that care be taken to ensure a level playing field between domestic and foreign banks. Directors looked forward to continued U.S. leadership in advancing the global financial regulatory reform agenda.

Directors acknowledged recent initiatives to address remaining weaknesses in the housing market. They encouraged further steps to improve the availability of mortgage financing and to clarify the role of the government in housing finance, including through administrative action as efforts on broader legislative changes continue.