Originally created 04/15/04

IMF warns U.S. budget deficits could depress world economy



WASHINGTON -- Uncontrolled U.S. budget deficits would pose a serious threat to global prosperity in coming years as rising interest rates depress economic growth in the United States and around the world, the International Monetary Fund warned Wednesday.

The IMF released a new analysis that predicted if nothing is done to get control of the soaring U.S. deficits, it would shave global economic output by 4.2 percent by 2020 and reduce U.S. economic growth by 3.7 percent during the same period.

IMF economists said much of the adverse impact would occur because of increased borrowing demands in the United States to finance the budget deficit. This would drive up U.S. interest rates and interest rates in other countries as the global supply of available capital is reduced, they said.

"The rest of the world is affected seriously by the U.S. fiscal deficit," IMF chief economist Raghuram Rajan told reporters in a briefing on the new report.

The IMF's forecast that the U.S. budget deficit will be a significant drag on growth reflected what will occur if there is no improvement in the deficit, which the Bush administration projects will hit $521 billion this year, a record in dollar terms, and show little improvement in coming years.

President Bush submitted a budget to Congress this year which projects that he will be able to cut the deficit in half over the next five years, reducing it to a shortfall of $237 billion in 2009.

The IMF said that if Bush is able to accomplish that such a reduction in the budget deficit, it would significantly lower, but not eliminate the adverse effects from the deficit on the U.S. and global economies.

It saw a long-run impact from such a budget reduction as reducing global economic output by 2.55 percent, compared to a reduction of 4.2 percent under the worst-case scenario in which the deficit remains at the current record levels.

Under the Bush program to reduce the deficit, U.S. economic growth will be depressed by 1.88 percent in the long-term, compared to 3.68 percent under the more adverse deficit path.

However, the IMF said that if the United States decided to pursue more rapid deficit reduction, the adverse drag on growth would be greatly reduced to just 1.03 percent in the long-term in the United States and 1.47 percent worldwide.

"It would be good if there were stronger measures put in place to contain the deficit and that is what we are looking for," Rajan told reporters.

The IMF analysis of the economic impact of the U.S. budget deficits represented the latest in a series of reports in which the 184-nation international lending agency has urged stronger measures to get control of the deficit.

The IMF report conceded that the U.S. deficit, which reflected in part the impact of President Bush's tax cuts, was useful in helping the United States and the global economy recover from the adverse effects of a number of shocks such as the 2001 recession, the terrorist attacks and the bursting of the stock market bubble.

While interest rates have yet to show significant increases in spite of the large budget deficits, the IMF said it was only a matter of time before rates did start to rise, reflecting an improving economy, increased demand for credit by businesses and actions by the Federal Reserve to start raising interest rates to keep inflation under control.

The IMF said it was important to make as much progress as possible to get the deficit under control now, before rising interest rates greatly increase the cost of servicing government debt.

It also warned that the huge U.S. budget deficit could have other adverse impacts on the U.S. economy such as helping increase the country's foreign trade deficit and putting downward pressure on the U.S. dollar.

The IMF analysis of the U.S. budget deficit was contained in the analytical chapters of its World Economic Outlook, which will be released in full next week in advance of the spring meetings of the IMF and the World Bank.

The United States is likely to face criticism at those meetings from other countries about the need to reduce its budget deficit and trade deficit in order to lower risks to the global economy.

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International Monetary Fund: http://www.imf.org