**INTERNATIONAL MONETARY FUND**

2002 Article IV Consultation with the United States of America

**Statement of the Fund Mission**

June 18, 2002

1.  ***The U.S. economy has shown impressive resilience during the past
    year.*** Following the longest expansion on record, the economy
    slipped into recession in early 2001. However, despite the
    subsequent shock to confidence and activity from the
    September 11^th^ terrorist attacks, domestic demand has bounced
    back, and timely fiscal and monetary stimulus in 2001, as well as
    continued productivity gains, have contributed to an unusually mild
    downturn. This favorable performance has contributed importantly to
    the recent improvement in global economic conditions.

2.  ***The outlook also appears broadly favorable.*** While IMF staff
    expects activity to moderate from the rapid growth seen in the first
    quarter, as the initial push from the inventory cycle and the effect
    of other temporary factors dissipate, the recovery would be
    sustained by a rebound of business fixed investment and continued
    strength in the household sector. Of course, important uncertainties
    remain, including with regard to the prospects for corporate profits
    and investment, the underlying strength of household demand, and the
    large U.S. current account deficit. How these uncertainties are
    resolved depends critically on the extent to which the U.S. economy
    can sustain the rapid rates of productivity growth that have been
    recorded in recent years.

3.  ***Against this background, the key policy challenges have shifted
    from short-term stabilization to strengthening the base for strong
    and durable growth:***

-   Provided that evidence of recovery continues to accumulate, monetary
    policy will need to start shifting to a more neutral stance.

-   Re-establishing a clear medium-term fiscal framework would help to
    strengthen budget discipline and to prepare for an aging society.

-   While the economic downturn and recent corporate failures have
    demonstrated the resiliency of the financial system, they have also
    highlighted a number of issues in the areas of corporate governance
    and accounting standards.

-   Recent U.S. trade action and agricultural policy initiatives are
    likely to impose a significant burden both domestically and abroad,
    and it will be important to avoid undermining the momentum toward
    multilateral trade liberalization.

4.  ***The large U.S. current account deficit, and the broader imbalance
    of global growth that it reflects, remain a concern***. The widening
    of the U.S. current account since the mid-1990s has largely resulted
    from strong investment and confidence in U.S. productivity growth
    relative to other industrial countries, rather than major fiscal or
    other macro-policy imbalances. Nonetheless, the current account
    deficit, at current or higher rates, would take the U.S. net foreign
    liability position to ever increasing levels, and at some point an
    adjustment will be needed. This adjustment could be achieved in an
    orderly fashion as a result of improved growth performance among
    partner countries. However, less orderly adjustments can also be
    envisaged, including through a sudden reversal of investor sentiment
    and capital flows, and rapid dollar depreciation. Such a process
    could jeopardize recovery prospects abroad, disrupt capital market
    access for developing countries, and also adversely affect U.S.
    investment and incomes. This risk underscores the importance of
    boosting U.S. saving---especially through disciplined fiscal
    policies---as well as continued efforts to ensure that risk
    management and transparency in the financial and corporate sectors
    are strong enough to maintain confidence and cope with exchange
    market and other shocks.

5.  ***The fiscal outlook has deteriorated markedly over the past
    year.*** A year ago, projections were for unified surpluses of
    2½ percent of GDP and higher in FY 2002 and beyond, permitting a pay
    down of net federal debt held by the public by the end of the
    decade. However, a deficit of well over 1 percent of GDP now seems
    likely in FY 2002, reflecting the effects of the economic slowdown,
    as well as the June 2001 tax cuts, additional outlays necessitated
    by the September 11^th^ attacks, and the March 2002 stimulus
    package. Although the Administration's budget projects that
    surpluses would be re-established on a unified basis after FY 2004,
    deficits would remain after excluding the surpluses of Social
    Security trust funds.

6.  ***Moreover, these medium-term fiscal projections could be
    optimistic.*** In order to offset significant increases in defense
    and security-related outlays, the budget proposes squeezing other
    spending categories to an extent that could be difficult to sustain,
    especially given the apparent weakening of fiscal discipline in
    recent years. Budget projections may also significantly understate
    the growth of Medicare outlays. On the tax side, the revenue/GDP
    ratio has already eroded owing to the effects of previously enacted
    tax cuts, and further declines cannot be ruled out given the recent
    weakness in tax receipts and the likely renewal of tax credits and
    relief from the individual Alternative Minimum Tax.

7.  ***Longer-run pressures on the fiscal system from demographic trends
    also remain worrisome.*** The cash-flow positions of the Social
    Security and Medicare trust funds are projected to deteriorate
    beginning later this decade, owing to the retirement of the
    baby-boom generation and the rapid growth of medical costs. The
    deficits that are expected to emerge next decade imply a substantial
    actuarial shortfall over a 75-year horizon, and the fiscal burden
    would be even larger if Medicare's Supplemental Medical Insurance is
    accounted for.

8.  ***As a first step toward addressing these longer-term pressures,
    the IMF staff recommends the establishment of a fiscal framework
    that sets the clear goal of balancing the budget excluding Social
    Security as the economy moves toward full employment**.* This
    objective---which the Administration endorsed last year---would
    allow federal debt to be worked down in anticipation of reforms that
    would place the Social Security and Medicare systems on a sound
    financial footing. If achieved over the business cycle, it would
    also provide sufficient flexibility for the fiscal position to
    respond to cyclical shocks. Early action toward establishing such a
    framework would help bolster fiscal discipline, strengthen
    confidence in the medium-term fiscal position, and ultimately boost
    national saving.

9.  ***Achieving this goal would require a careful and early review of
    expenditure and tax priorities.*** The Administration's budget
    already anticipates tight limits on nondefense discretionary outlays
    that may be hard to achieve, especially in light of recent pressures
    for spending on homeland security and agricultural subsidies.
    Therefore, consideration may need to be given to revenue measures.
    The Administration has signaled its interest in tax reforms that
    improve the efficiency and breadth of the system. In this context,
    the IMF staff suggests that priority be given to reducing tax
    expenditures for both households and corporations, and the possible
    increased use of energy taxes. In the absence of alternatives, the
    pending cuts in marginal income tax rates may need to be
    reconsidered.

10. ***Strengthening the institutional basis for budget discipline would
    bolster the credibility of the fiscal framework***. Discretionary
    spending caps and the pay-as-you-go (PAYGO) requirements played an
    important role in asserting budgetary discipline during the past
    decade, but were increasingly circumvented once on-budget surpluses
    began to accumulate. The credibility and transparency of the budget
    process also seemed to have been weakened by decisions to legislate
    last year's tax cuts only through 2010 and to forego ten‑year budget
    projections. Therefore, while an extension of spending caps and
    PAYGO mechanisms could be useful, strengthening enforcement
    mechanisms and a strong political consensus for fiscal consolidation
    are also needed.

11. ***Steps need to be taken to address the longer-term health of the
    Medicare and Social Security systems***. The budget acknowledges the
    need for Medicare reform, but the specific measures announced seem
    geared more toward expanding benefits---including for prescription
    drugs---than ensuring the system's long-term viability. Placing the
    system on a sound financial footing will undoubtedly require
    measures to contain the cost of health care, raise co-payments and
    deductibles, and increase contribution and premium rates. As for
    Social Security, the Administration has stressed its preference for
    solutions that avoid hikes in payroll taxes. However, as the
    President's reform commission has illustrated, early and relatively
    modest amendments to other aspects of the current system---for
    example, amending the indexation of the benefit formula that applies
    to pre-retirement earnings---could help assure the system's
    financial solvency and avoid the need for larger and more difficult
    measures later on. In the staff's view, other alternatives such as
    gradually increasing the retirement age and raising the ceiling on
    OASDI contributions could also be considered. Proposed personal
    retirement accounts could enhance incentives to save and
    inter-generational equity, but they would not substitute for the
    measures needed to address the system's long-term solvency, and
    would require coping with significant transition costs.

12. ***Provided that evidence of recovery continues to accumulate, the
    Federal Reserve will need to begin to gradually withdraw monetary
    stimulus.*** Interest rates are highly accommodative, and given
    expectations of a gradual absorption of slack in the coming year and
    the usual transmission lags, the market expects action to begin
    withdrawing stimulus later this year. To be sure, the Fed has some
    room to wait until the recovery is more clearly established before
    acting, given the minimal signs of impending inflation pressures and
    the still uncertain economic outlook. Nonetheless, these
    considerations will need to be balanced against the possibility that
    delaying action would require larger and more disruptive policy
    adjustments later on.

13. ***The U.S. financial system appears to have successfully weathered
    the economic slowdown***. Although credit quality weakened further
    during 2001, banks have maintained healthy returns on equity and
    boosted capital, and improved risk-management techniques have
    allowed banks to handle substantial stresses. Pressures may still
    arise owing to weaknesses in some sectors, but systemic risks appear
    limited. The new supervisory framework established under the
    Gramm-Leach-Bliley (GLB) Act of 1999 also seems to have been
    implemented effectively, and the authorities' intention to reform
    the deposit insurance system and to press ahead toward a new
    international capital accord are welcome.

14. ***The failure of the Enron Corporation has triggered valuable
    scrutiny of U.S. corporate governance and accounting standards***.
    Spillovers to the financial and corporate sectors appear to have
    been largely contained, and the event appears to have had the
    welcome effect of encouraging stricter market discipline.
    Nonetheless, it has highlighted a number of shortcomings in
    accounting and audit standards, corporate governance, and
    regulations governing pension plans. The challenge will be to ensure
    that reform proposals are developed and implemented in a manner that
    enhances transparency and market discipline without unduly adding to
    the regulatory burden.

15. ***The United States has played an important leadership role in
    advancing the Doha Round,*** and has also demonstrated a willingness
    to advance the cause of free trade in the context of efforts toward
    a Free Trade Agreement of the Americas and increased market access
    for the Caribbean and Sub-Saharan Africa. Looking ahead, advancing
    the implementation of measures already agreed under the Uruguay
    Round Agreement would bolster confidence among partner countries
    that the benefits of trade liberalization are being shared
    equitably.

16. ***Nonetheless, this leadership role and broader support for
    multilateralism risks being undermined by domestic pressures*.** The
    recent safeguard action against steel imports appears likely to
    impose significant costs both domestically and abroad and, by
    raising trade tensions, could undermine momentum for multilateral
    trade liberalization. Also, as slack emerged in the industrial
    sector, U.S. anti-dumping filings surged in recent years. These
    actions tend to discourage competition and trade, and encourage
    similar behavior by partner countries, suggesting the need for
    reforms that reduce the degree of discretion allowed in findings of
    injury and more clearly link findings to evidence of noncompetitive
    behavior.

17. ***The measures contained in the recent Farm Bill were damaging from
    both a domestic and international perspective.*** The legislation
    locks in U.S. subsidies at levels that---while lower than in many
    partner countries---have surged in recent years, undoing many of the
    1996 reforms that sought to promote adjustment and efficiency in the
    farm sector. By linking support payments to prices of specific
    commodities, the legislation seems likely to encourage production of
    crops already in chronic oversupply and adversely affect producers
    abroad, while also undermining domestic fiscal objectives.

18. ***U.S. overseas development assistance (ODA) remains low.***
    Despite increases in 2001, U.S. ODA remains only around 0.1 percent
    of GNP, one of the lowest ratios among industrial countries. Recent
    Administration proposals to increase ODA outlays beginning in
    FY 2004 are welcome, but these would still leave overall ODA
    spending as a share of GNP well below the U.N. target and the lowest
    among industrial countries.