DOCUMENT OF INTERNATIONAL MONETARY FUND AND FOR OFFICIAL USE ONLY

 BUFF/ED/15/89

July 1, 2015

Statement by Mr. Sobel and Ms. Douglass Kochman on United States

Executive Board Meeting

July 6, 2015

The U.S. economy remains on a solid footing and underlying fundamentals support

above-trend growth going forward. Notwithstanding a slight contraction in the first quarter

due in large part to transitory factors, the momentum behind the U.S. recovery continues,

underpinned by consumption buoyed by robust job growth, wealth effects and improved

household balance sheets, a firm housing market outlook, and a broadly neutral fiscal stance. 

External factors, including the lack of robust global growth, pose a downside risk to the

recovery, as growth is being restrained by a significant drag from net exports. 

In 2014, our economy achieved a number of important milestones. We added more

jobs than any year since the late 1990s, building on five years of private sector job growth,

driven by the manufacturing sector. The U.S. is producing more oil than it imports for the

first time in two decades and is now the world’s leading producer of petroleum and natural

gas. 

After fiscal policy played a supportive role at the outset of the crisis, the federal

deficit has improved considerably, exhibiting the largest five-year decline since the

demobilization from World War II. Inflation remains below the Federal Open Market

Committee’s (FOMC) longer-run objective, partly reflecting earlier declines in energy prices

and decreasing prices of non-energy imports. The FOMC continues to judge that the first

increase in the federal funds rate will be appropriate when it has seen further improvement in

the labor market and is reasonably confident that inflation will move back to its 2 percent

objective over the medium term.

Growth and financial stability have been supported by measures taken since the crisis

to provide a credible and transparent assessment of our financial system’s weaknesses and

implement regulatory reform. We welcomed the opportunity to engage with the staff in the

context of the Financial Sector Assessment Program. The Dodd-Frank Act (DFA) celebrates

its fifth anniversary this month and has already transformed and strengthened the U.S.

financial regulatory landscape. We will continue to finalize its implementation, while

remaining vigilant about emerging risks. 

We thank the staff for their dialogue with our authorities and are in general agreement

with many of their analyses and policy recommendations. We also thank them for their
thoughtful working papers and Selected Issues Paper, which explore a number of issues

relevant to the U.S. economy.

ECONOMIC OUTLOOK

The U.S. economy appears to have entered a period of self-sustaining growth. While

the economy contracted by 0.2 percent in the first quarter of 2015, activity was held back by

transitory factors, including harsh weather, the West Coast ports labor dispute, a drop in

business investment for oil exploration in response to low oil prices, and a decline in U.S.

exports. 

Nevertheless, the economy remains on solid footing. Consumer spending growth

appears to have accelerated to a 2.5 to 3 percent annual rate in the second quarter. Consumer

confidence is near its highest levels since 2007, before the recession, as labor market

conditions continue to improve and stronger household balance sheets are underpinning

disposable income. Nonfarm payroll employment rose 280,000 in May, accelerating from

April and March, with a total of 12 million jobs added since early 2010. The unemployment

rate was 5.5 percent in May, just 0.1 percentage point higher than the seven-year low reached

in April as more workers joined the labor force; and the labor force participation rate has

stabilized – albeit at a relatively low rate. Household debt as a share of disposable income is

near a thirteen year low, while net worth has risen 54 percent from its 2009 low and is about

$17 trillion above its peak in second quarter 2007. 

The pace of business investment has been modest during this recovery as firms have

held large amounts of cash, suggesting they may have lacked sufficient confidence in the

strength and durability of the recovery to undertake substantial capital expenditures. 

However, as recovery takes hold, there is substantial room for strengthening. As the staff

report notes, investment in the energy sector, in particular, has fallen in 2015 much faster and

more significantly than many expected.

INTERNATIONAL OUTLOOK

The U.S. economy is helping propel economic expansion globally. But the rest of the

world should not depend on the United States to be a key engine of growth. In this light, we

are not persuaded by staff’s characterization that global adjustment of exchange rates has

represented a warranted shift of demand, in particular to large surplus countries that are

threatened by deflation and stagnation. Staff projects net exports will subtract nearly threequarters of a percentage point from GDP growth this year and a medium term widening in

the current account deficit reflecting global growth differentials. In our view, the first-best

outcome for the global economy and the U.S. economy would be further efforts to lift overall

global growth by strengthening domestic demand, especially in surplus economies, rather

than continued reliance on external demand. The U.S. cannot be the importer of first and last

resort, or a “sponge” for the global economy as our authorities stated during the Article IV

consultations. 

FISCAL POLICY

In the wake of the crisis, fiscal policy was targeted at supporting near-term growth

and job creation. As the economy found its footing, measures were taken to reduce spending

and increase revenue, although these actions had a more immediate impact than desired at the

time. Nevertheless, combined with rising growth, they helped set in motion the fastest pace

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of U.S. fiscal consolidation in more than 60 years, reducing the deficit from a peak of 9.8

percent of GDP in 2009 to 2.8 percent of GDP in FY 2014, its lowest share since 2007. 

Private sector estimates point to further reductions this year in the deficit. This progress

reflects the effects of both legislation and economic growth.

After this considerable reduction in the federal fiscal deficit, fiscal policy is no longer

a drag on economic activity. Further, over the past year, we have seen real progress in

returning to regular order in conducting fiscal policy. The Bipartisan Budget Act of 2013

reversed a portion of sequestration and allowed for higher investment levels in 2014 and

2015. The Administration’s FY 2016 Budget would lower the deficit to a sustainable level

and put debt as a share of GDP on a declining path as early as next year, while envisioning a

fully paid-for increase in the discretionary budget caps to make room for a range of

investments, including in education, job training, research, manufacturing, and infrastructure. 

The Administration’s FY 2016 Budget includes a set of detailed business proposals

that would close loopholes and provide incentives for growth in a fiscally responsible

manner. These proposals would simplify compliance and provide tax relief to small

businesses, and provide incentives for manufacturing, research, clean energy, regional

growth, and infrastructure. The proposals also would eliminate fossil fuel preferences,

reform the taxation of financial and insurance products, and close loopholes in and

fundamentally reform the U.S. international tax system. One of the principal proposals

would impose a one-time transition toll charge on untaxed foreign earnings that U.S.

companies have accumulated overseas, which would raise enough revenue to fill the

projected shortfall in the Highway Trust Fund and make new investments as part of the

President’s six-year surface transportation reauthorization.

We appreciate the report’s attention to the policy agenda in areas affecting long-term

growth. The issues of poverty and inequality are important ones, as the benefits of growth

are not being shared by all Americans. The Administration’s FY 2016 budget would

simplify and expand child care tax benefits; enhance educational opportunities by partnering

with states to make community college and career and technical schools free for responsible

students; expand education tax incentives; make it easy and automatic for workers to save for

retirement; and raise the minimum wage. 

Looking forward, the deficit is forecast to decline slightly further on net over the next

few years, stabilizing at 2.5 percent over the latter half of the 10-year budget window. At the

same time, our ongoing growth-oriented investments will help enhance the sustainability of

the public debt ratio by boosting the denominator. Debt would stabilize at 75 percent of

GDP in the current fiscal year and decline slightly over the next ten years.

MONETARY POLICY

On June 17, the FOMC reaffirmed the current 0 to 0.25 percent target range for the

federal funds rate. Inflation continues to run below its longer-run objective, but some of the

downward pressure resulting from earlier sharp declines in energy prices is abating. The

FOMC continues to indicate that the first rate increase will be appropriate when it has seen

further improvement in the labor market and is reasonably confident that inflation will move

back to its 2 percent objective over the medium term. 

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In regard to the timing of policy normalization, Fund staff expresses the view that it is

preferable to move later, rather than too early. The FOMC has emphasized repeatedly that it

will determine the timing of the initial increase in the federal funds rate on a meeting-bymeeting basis, depending on its assessment of incoming economic information. More

fundamentally, while the timing of the first rate hike receives a lot of attention, the path of

subsequent policy rate changes is of greater importance. Indeed, the stance of monetary

policy will likely remain highly accommodative for quite some time after the initial increase

in the federal funds rate in order to support continued progress toward the objectives of

maximum employment and 2 percent inflation. 

Effective communications have been a cornerstone of the FOMC’s approach. The

Federal Reserve has been and remains committed to communicating as clearly and

effectively as possible to help mitigate the risk of sudden changes in the policy outlook

among market participants that could spur unintended effects in global financial markets. In

terms of potential spillovers, staff rightly emphasizes that higher interest rates that are driven

by a robust economy moving closer to maximum employment should be a positive force for

the world economy.

When considering staff’s recommendations on communications more generally, such

as more press conferences and a quarterly monetary policy report, it is important to note that

the Federal Reserve already has at its disposal many avenues of communication. These

include the issuance of the Summary of Economic Projections four times per year, press

conferences by the FOMC Chair four times per year, and publication of the monetary policy

report twice yearly, as well as speeches and testimony by Federal Reserve officials. Building

consensus around an FOMC-endorsed forecast, as staff recommends, would be practically

challenging given its 19 members and their varying views. Such an approach risks

eliminating the richness of information currently provided on the diversity of views within

the FOMC.

We appreciate the staff’s thoughtful consideration of the role for monetary policy in

promoting financial stability but agree that it faces significant limitations in this respect. Its

effects on financial vulnerabilities are not well understood and are less direct than a

regulatory or supervisory approach. Further, efforts to promote financial stability through

adjustments in interest rates would increase the volatility of inflation and employment.

FINANCIAL SECTOR

In undertaking the FSAP, the Fund rightly holds the United States to the highest and

most stringent standards, given the complexity, maturity, and systemic importance of our

financial sector. Despite this higher standard, the assessment found the U.S. regulatory

system to be very strong and, in many ways, more rigorous than international standards.

We agree with staff’s conclusion that with a strengthened capital position, less

leverage, and more liquid assets, the U.S. banking system appears resilient to a range of

extreme market and economic shocks. Staff also notes that federal banking agencies have

improved considerably in effectiveness and achieve a high degree of compliance with

international standards. Global and domestic reforms, particularly the DFA, have increased

the intensity of supervision and the resilience of our financial system. All banks are required

to hold significantly more capital, with higher standards applied to the largest, most

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systemically important firms. Large institutions have also been required to substantially

increase their liquidity. Substantial improvements have been made in risk management and

the oversight of large bank organizations by putting enhanced emphasis on banks’ capital

planning, stress testing, and corporate governance. The U.S. not only meets many Basel III

requirements, as reflected in the FSAP, but significantly exceeds some of the most important

ones for our largest, most global, systemic bank holding companies, especially those related

to capital, leverage, and liquidity. 

Taking into account the lessons from the crisis, we have built on the FDIC’s world

class resolution framework for banks and, as staff concludes, we have significantly

strengthened our resolution framework to help end too-big-to-fail. One of the DFA’s key

reforms is the Orderly Liquidation Authority (OLA), which under certain conditions allows

regulators to take over a failing financial company and wind it down in an orderly manner. 

We found the process underpinning the Technical Note on the Key Attributes for Effective

Resolution especially valuable, as it generated feedback to enhance the ongoing development

of the assessment methodology, while staff concluded that our resolution regime as set out in

OLA and the Federal Deposit Insurance Act is in broad conformity with the FSB Key

Attributes. 

As staff emphasizes, the U.S. remains at the forefront of international policymaking

in matters pertaining to bank resolution. The FDIC and Bank of England developed a

“Single Point of Entry” strategy, which is a top-down approach that reduces the incentives of

host countries to ring fence assets and promotes financial stability by allowing subsidiaries to

continue operating. The U.S. helped lead the effort at the FSB to develop a new standard on

total loss absorbing capacity for globally systemic important banks. Already, the Financial

Stability Oversight Council (FSOC) recommended in its 2015 annual report that the U.S.

authorities work to propose regulations regarding the maintenance of minimum amount of

long term debt at the holding company level of systemically important financial institutions.

Like staff, we believe that the derivatives and securities regulatory and supervisory

framework has improved considerably. We have led the way in implementing the G-20

Pittsburgh Summit commitments to clear, trade, and report OTC derivatives transactions. 

Mandatory reporting and trading requirements for certain OTC swaps are now in effect. 

Central clearing of credit derivatives by firms in the U.S. has grown from zero in 2009 to 81

percent in 2014. At the end of 2014, approximately 65 percent of interest rate swaps were

cleared.

Market based financing makes our economy more resilient and dynamic because it

provides a valuable alternative to bank funding. This strengthens the way that the financial

system supports economic growth. At the same time, “shadow banking” can be a source of

potential systemic risk and we remain vigilant about the migration of activities to the nonbank financial sector. The DFA has widened the perimeter of regulation to cover more

market-based financing activities, and the FSOC has a thorough process for reviewing such

risks and proposing remedies by the appropriate regulator or supervisor, if needed. The U.S.

has taken regulatory action in relation to money market funds, securitization activities, and

the tri-party repo market. The FSOC continues to analyze whether and how asset

management products and activities could pose risks to U.S. financial stability. The SEC has

expanded and deepened its oversight of the asset management industry to better identify,

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monitor, and evaluate risks and facilitate appropriate responses. Recent efforts have included

developing recommendations to modernize and enhance data reporting; considering whether

broad risk management programs should be required for mutual funds and ETFs to address

risks related to their liquidity and leverage; and considering ways to implement the new

requirements for annual stress testing by large investment advisers and large funds, as

required by DFA. We welcome the FSB’s continued work on developing policy

recommendations aimed at further strengthening shadow banking into resilient market-based

financing and this year’s FSB-led peer review of shadow banking frameworks in member

countries represents a notable milestone. 

Staff underscores that the FSOC filled a major gap in our financial stability

framework. Five years into its operations, it has made substantial strides in risk identification

and designation and addressed data gaps. It has demonstrated a sustained commitment to

working collaboratively to fulfill its statutory mission in a transparent and accountable

manner. In response to stakeholder suggestions, it has adopted a number of policy and

procedural changes over the past year, including supplemental guidance to the nonbank

designations process, committee structure reforms, and transparency policy revisions.

Last year, regulators took steps to improve data scope, comparability, and

transparency, including through a joint effort by the CFTC and Office of Financial Research

to enhance the quality, types, and formats of data collected from swap data repositories. 

Recognizing that gaps remain, the FSOC recommended that regulators and market

participants continue to work to improve data quality, access, and comprehensiveness and

member agencies continue to explore best practices for data sharing and reporting efficiency.

We appreciate staff’s attention to liquidity conditions, and the evolution of market

structures deserves close attention. However, data do not reveal clear evidence of a

widespread, substantial decline in market liquidity. Staff makes the case that new financial

regulation has substantially reduced liquidity in many markets, but there are many other

forces that need to be considered in order to mandate changing market dynamics, including

the expansion of electronic trading, changing business models, and the risk appetite of

broker-dealers, and other competitive and technological changes. Looking forward and

consistent with periods preceding previous interest rate increases, it may be reasonable to

expect a possible increase in market volatility as monetary policy conditions are normalized. 

Further, financial regulation has clearly made the system safer and more resilient.

We welcome staff’s conclusions that the U.S. insurance system broadly indicates

compliance with Insurance Core Principles; that insurance supervision has been significantly

strengthened; and that many of the 2010 FSAP recommendations are being addressed. The

FSOC has recommended that the Federal Insurance Office and state insurance regulators

continue to closely monitor and assess the growing risks that insurers have taken by

extending the duration of their portfolios and investing in lower-quality or less-liquid assets. 

Finally, the Administration remains committed to long-term housing finance reform. 

In the absence of comprehensive legislation, we believe significant progress can be made

administratively.

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