The American flag flies outside the U.S. Capitol before sunrise in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

U.S. Fiscal Stimulus Raising Risks to Global Economy: IMF

(Bloomberg) -- U.S. tax cuts and public-spending hikes are increasing risks to the global economy by boosting debt, potentially stoking inflation and pushing the dollar higher, the International Monetary Fund warned.

Fiscal stimulus backed by the Trump administration and the Republican-controlled Congress will give a short-term boost to the U.S. and many of its trading partners, the IMF staff said in a statement Thursday on its annual checkup of the U.S. economy. However, adding fiscal measures at a time when the economy is growing “will elevate the risks to the U.S. and the global economy,” said the Washington-based fund.

The loosening of the purse strings in Washington raises the risk of an “inflation surprise” for markets, the IMF warned, adding a rapid rise in price pressures would force the Federal Reserve to hike interest rates faster than expected. The IMF, which last week announced a record $50 billion loan program for Argentina, said it’s seeing signs that U.S. fiscal policy may be causing capital flight from emerging markets.

The warning comes amid the strongest global upswing in seven years. While the fund sees global growth accelerating in 2018, it has predicted momentum will ebb in coming years as central banks raise rates and the effects of the U.S. fiscal stimulus fade.

IMF Managing Director Christine Lagarde warned this week that clouds over the world economy are “getting darker by the day.” Her remarks followed a chaotic Group of Seven summit in which President Donald Trump revoked support for a joint statement disavowing protectionism.

U.S. Fiscal Stimulus Raising Risks to Global Economy: IMF

The near-term outlook for the U.S. economy is strong, the IMF said, noting that unemployment is near levels not seen since the 1960s. The U.S. is probably already past so-called full employment, but wages and prices are expected to increase at a “slow but steady” rate, it said.

U.S. Pushes Back

The U.S. Treasury said in a statement that it shared the fund’s short-term assessment of the U.S. economic outlook, but “we differ significantly on the medium and long term projections.”

U.S. cuts to corporate and personal income taxes worth $1.5 trillion took effect in January, while Congress passed $300 billion in federal spending increases in February. The government stimulus will raise the U.S. budget deficit to more than 4.5 percent of gross domestic product by next year, the IMF said.

The Trump administration plans to gradually tighten spending in 2020. But there’s a risk the U.S. could fall into recession, the IMF warned, since the Fed is likely to be raising borrowing rates at the same time.

In light of the fiscal stimulus, the Fed “will need to raise policy rates at a faster pace” to achieve its dual mandate of delivering sustainable employment and containing inflation, the IMF said. The Fed “should be ready to accept some modest, temporary overshooting of its medium-term inflation goal,” according to the fund.

The IMF praised several aspects of the tax cuts, saying lower corporate rates will stimulate investment. However, it said that, on a net basis, the tax changes give greater benefits to people in the highest income classes.

“These changes are likely to exacerbate income polarization and will do little to address the pressing needs of the working poor,” the IMF said.

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