Abstract
The U.S. economy continued to grow strongly over the year even in the face of a withdrawal of monetary stimulus and high oil prices. Executive Directors commended the Federal Reserve for its monetary tightening. They recognized that the financial sector has proven innovative and resilient. They cautioned that demographic and other pressures will continue to threaten long-term fiscal sustainability and economic prospects. They agreed that the country has a key role in catalyzing vigorous implementation of the cooperative strategy laid out by the International Monetary and Financial Committee.
1. This note reports on information that has become available since the staff report was issued. The topics covered include the recent economic and financial market developments, monetary policy prospects, and the budget outlook. They do not affect the staff appraisal.
Recent economic and financial market developments
2. Recent developments continue to point to a gradual slowing in activity. June payroll employment rose by only 121,000, but with stronger growth in the household employment survey, the unemployment rate remained steady at 4.6 percent. Indicators continue to suggest that the housing market is cooling, with weaker housing starts and building permits in June. Retail sales retreated 0.1 percent and producer and consumer sentiment have both softened. However, industrial production increased 0.8 percent in June, and relatively strong export growth helped keep the trade deficit broadly stable at $63.8 billion in May, suggesting an upside risk to the staff’s estimate of real net exports.
3. Core CPI inflation again exceeded expectations in June. The 12-month increase in overall and core consumer prices ticked up to 4.3 percent and 2.6 percent, respectively, with the increase in core inflation slightly above market expectations. While 12-month core producer price inflation was stable and in line with expectations at 1.9 percent, headline PPI inflation rose to 4.8 percent and hourly wage growth accelerated to close to 4 percent in June. However, spreads between conventional and inflation-indexed 10-year bonds remained stable at around 2.6 percent, suggesting that inflation expectations remain relatively well anchored.
4. U.S. financial markets have softened in response to signs of slowing activity. Long-term bond yields have decreased by about 10 basis points to just over 5 percent and equity prices have fallen by 1½ to 2 percent since end-June. Market expectations regarding the near-term course of monetary policy have remained broadly unchanged, with futures prices suggesting a roughly 50 percent probability of a 25 basis point hike in the federal funds rate at the early August meeting of the Federal Open Markets Committee.
Monetary and fiscal developments
5. The Federal Reserve’s semi-annual Monetary Policy Report (MPR) was presented to Congress on July 19 by Chairman Bernanke. The MPR projects that core PCE inflation (which has been running around a ¼ percentage point lower than core CPI inflation) will likely ease from around 2¼–2½ percent in 2006 (fourth quarter on fourth quarter) to slightly above 2 percent in 2007. Economic growth is projected to moderate from around 3¼–3¼ percent this year (again fourth quarter on fourth quarter) to around 3–3¼ percent in 2007. Both forecasts are broadly in line with staff projections. The Chairman acknowledged the recent rise in core inflation but appeared confident that, with growth slowing, inflation would ease later in the year, prompting markets to rally.
6. The Administration’s Mid-Session Review sharply lowered the forecast budget deficit for this year to a level consistent with staff projections. Reflecting buoyant and broad-based revenue growth through June, the Administration lowered its projection for the FY 2006 unified federal deficit (ends this September 30) to $296 billion (2¼ percent of GDP), from its February estimate of $423 billion (3¼ percent of GDP), leaving the forecast identical to the staff’s. The strong revenue growth, together with expectations of further compression in the expenditure ratio beyond FY 2008 owing to higher growth, have also led the Administration to reduce projected deficits for FY2007–11 by ¼–½ percent of GDP (Table), with the unified federal deficit projected to fall below 1 percent of GDP by FY 2010.
7. The Mid-Session Review emphasized the need to address the long-term fiscal challenge posed by the unsustainable growth in entitlement spending. It noted that “…entitlement spending in Social Security, Medicare, and Medicaid is growing faster than the economy and the Nation’s ability to pay for this spending. No plausible amount of cuts to discretionary programs or tax increases can avert this major fiscal challenge,” underscoring the urgent need for entitlement reform.
United States: Unified Budget
(Percent of fiscal year GDP)
In contrast to the FY 2007 budget (released February 2006), the mid-session review includes a $108 billion allowance for the costs of operations in Iraq and Afghanistan in FY 2008-11.
United States: Unified Budget
(Percent of fiscal year GDP)
| FY 2005 | FY 2006 | FY 2007 | FY 2008 | FY 2009 | FY 2010 | FY 2011 | |||
|---|---|---|---|---|---|---|---|---|---|
| FY 2007 Mid-Session Review1 | |||||||||
| Outlays | 20.1 | 20.6 | 20.1 | 19.4 | 18.9 | 18.7 | 18.8 | ||
| Net interest expense | 1.5 | 1.7 | 1.8 | 1.8 | 1.8 | 1.8 | 1.8 | ||
| Revenue | 17.5 | 18.3 | 17.7 | 18.1 | 17.9 | 18.0 | 18.1 | ||
| Unified balance | -2.6 | -2.3 | -2.4 | -1.3 | -1.0 | -0.8 | -0.7 | ||
| FY 2007 Budget | |||||||||
| Outlays | 20.1 | 20.8 | 20.1 | 19.4 | 19.1 | 19.0 | 19.1 | ||
| Net interest expense | 1.5 | 1.7 | 1.8 | 1.9 | 1.9 | 1.9 | 1.9 | ||
| Revenue | 17.5 | 17.5 | 17.6 | 17.8 | 17.7 | 17.9 | 17.9 | ||
| Unified balance | -2.6 | -3.3 | -2.6 | -1.5 | -1.4 | -1.1 | -1.2 | ||
| Differences | |||||||||
| Outlays | -0.2 | 0.0 | 0.0 | -0.2 | -0.3 | -0.3 | |||
| Net interest expense | 0.0 | 0.0 | -0.1 | -0.1 | -0.1 | -0.1 | |||
| Revenue | 0.8 | 0.1 | 0.3 | 0.2 | 0.1 | 0.2 | |||
| Unified balance | 1.1 | 0.2 | 0.2 | 0.4 | 0.3 | 0.5 | |||
| Staff Forecast | |||||||||
| Unified Balance | -2.3 | -2.6 | -2.3 | -2.0 | -1.9 | -1.8 | |||
| Difference from Mid-Session Review | 0.0 | -0.2 | -1.0 | -1.0 | -1.1 | -1.1 | |||
In contrast to the FY 2007 budget (released February 2006), the mid-session review includes a $108 billion allowance for the costs of operations in Iraq and Afghanistan in FY 2008-11.
United States: Unified Budget
(Percent of fiscal year GDP)
| FY 2005 | FY 2006 | FY 2007 | FY 2008 | FY 2009 | FY 2010 | FY 2011 | |||
|---|---|---|---|---|---|---|---|---|---|
| FY 2007 Mid-Session Review1 | |||||||||
| Outlays | 20.1 | 20.6 | 20.1 | 19.4 | 18.9 | 18.7 | 18.8 | ||
| Net interest expense | 1.5 | 1.7 | 1.8 | 1.8 | 1.8 | 1.8 | 1.8 | ||
| Revenue | 17.5 | 18.3 | 17.7 | 18.1 | 17.9 | 18.0 | 18.1 | ||
| Unified balance | -2.6 | -2.3 | -2.4 | -1.3 | -1.0 | -0.8 | -0.7 | ||
| FY 2007 Budget | |||||||||
| Outlays | 20.1 | 20.8 | 20.1 | 19.4 | 19.1 | 19.0 | 19.1 | ||
| Net interest expense | 1.5 | 1.7 | 1.8 | 1.9 | 1.9 | 1.9 | 1.9 | ||
| Revenue | 17.5 | 17.5 | 17.6 | 17.8 | 17.7 | 17.9 | 17.9 | ||
| Unified balance | -2.6 | -3.3 | -2.6 | -1.5 | -1.4 | -1.1 | -1.2 | ||
| Differences | |||||||||
| Outlays | -0.2 | 0.0 | 0.0 | -0.2 | -0.3 | -0.3 | |||
| Net interest expense | 0.0 | 0.0 | -0.1 | -0.1 | -0.1 | -0.1 | |||
| Revenue | 0.8 | 0.1 | 0.3 | 0.2 | 0.1 | 0.2 | |||
| Unified balance | 1.1 | 0.2 | 0.2 | 0.4 | 0.3 | 0.5 | |||
| Staff Forecast | |||||||||
| Unified Balance | -2.3 | -2.6 | -2.3 | -2.0 | -1.9 | -1.8 | |||
| Difference from Mid-Session Review | 0.0 | -0.2 | -1.0 | -1.0 | -1.1 | -1.1 | |||
In contrast to the FY 2007 budget (released February 2006), the mid-session review includes a $108 billion allowance for the costs of operations in Iraq and Afghanistan in FY 2008-11.