The U.S. economy remains robust, entering its longest expansion on record and with encouraging trends in labor force participation, productivity and wage growth, notably for the lowest earners. Real GDP grew 3.1 percent in Q1 2019, well above private forecasts, with growth well supported by accelerating private investment, and by our tax and regulatory relief policies. In April 2019, the U.S. unemployment rate reached a 49-year low of 3.6 percent, where it remained in May. Importantly, the Administration’s policies have drawn workers back into the labor force in numbers that have helped offset downward pressure from population aging and supported a downward trend in poverty, which is nearing its historic low. Consistently solid productivity gains—including annualized productivity growth of 3.4 percent in Q1 2019—have driven real wage gains. Real average hourly wages grew 1.4 percent in the year to April 2019. Headline PCE inflation, the basis of the Federal Reserve’s inflation objective, rose 1.5 percent in the year to April 2019. Measures of consumer and business sentiment remain strong, indicating continued favorable economic prospects.
In this context, we thank staff and management for the constructive engagement with our authorities during the Article IV consultation. We value the IMF’s surveillance role and the opportunity to discuss our economic policy priorities and reflect on staff’s recommendations. We broadly agree with staff on the importance of translating economic growth into improved social outcomes, of remaining vigilant about financial stability risks, and of bending the curve of our public debt over time. We take note that IMF staff find the Federal Reserve’s monetary policy to be appropriate at this juncture. We would like to elaborate on our perspective on these issues, including how our current policies are making inroads on key challenges, and areas where we see things differently from staff.
Economic Outlook. We appreciate IMF staff’s recognition of the current strength of the U.S. economic expansion, but we are more optimistic than staff about the prospects for our tax and regulatory reforms to support growth in the coming years. We believe that latent productivity in the U.S. economy is considerably higher, previously held back by the deep slack of the Great Recession, an uncompetitive tax code, and costly regulation. We have now considerably reduced those drags. Moreover, the Administration expects that its policies to encourage work—such as reforms to social programs, strengthening skills training, and supporting greater labor mobility— could support faster growth in the labor supply and productivity. Taken together, these policies will boost real economic growth to about 3 percent annually this year and over the medium term.
Staff’s analysis of the tax reform misses important prospective supply side effects. Staff argues that increased U.S. investment to date can be largely explained by demand-side effects, and posits that supply side effects from tax reform may have been blunted by rising corporate market power. The Administration believes that with regulations related to the tax reform still being finalized, the investment-enhancing impact of the reform is only in its initial stage. We expect continued strength in investment over time, rather than the near-term fading expected by staff. We are also more optimistic about the lasting impact of continuous efforts to reduce the regulatory burden on the private sector.
Fiscal Sustainability. We recognize the long-term challenge of addressing our public debt and the Administration is approaching the issue on two fronts. First, our supply-side reforms will durably raise potential growth which will improve our debt-GDP dynamics. Second, the Administration’s planned reduction in non-defense discretionary spending, combined with healthcare and welfare reforms, will help stabilize public debt levels over the medium term and return the primary balance to a modest surplus position by 2024. Given continued low global interest rates and high U.S. GDP growth, we believe this has been an opportune time to create space for bold reforms to spur investment and private sector growth, avoiding the trap of a “new normal” of low GDP growth in the aftermath of the Great Recession.
Social Outcomes. The Administration is focused on ensuring that the U.S. economy is working well for all Americans. We acknowledge the past trend of rising income inequality, while noting that technological innovation and globalization make this a challenge across advanced economies. We see stronger wage growth and increased labor force participation as fundamental to improving welfare and inclusion. Importantly, lower income employees are seeing faster wage growth than high-income earners—nominal wage growth for the lowest decile has grown faster than median wages for the past two years. In addition, the recent tax reform included provisions to support low-income workers and families, including an expanded Child Tax Credit and retention of the Earned Income Tax Credit. We are encouraged by recent trends in the supplemental poverty rate, which has declined from its post-Great Recession peak of 16.1 percent in 2011 to 13.9 percent in 2017, while real median household income has been on an upward trend in recent years.
Our social welfare policies are focused on sensible reforms to move able-bodied individuals from welfare to work, and to focus the social safety net on those who need it most—the elderly, children and the disabled. We agree with staff that paid family leave and more access to quality child-care would better support working parents and the Administration has made proposals in its budget presentation to Congress. We also agree that healthcare inflation needs to be tackled, and the Administration has proposed policies to address the rise in drug costs in particular, to make inroads in this area. Some other Administration priorities in line with recommendations from IMF staff are skills training including formal apprenticeship programs and investments in science, technology, engineering, and math (STEM) education programs.
We agree with the IMF that opioid abuse remains a major concern, and we appreciate the acknowledgement of federal, state, and local efforts in the Managing Director’s press remarks. The Administration is working aggressively to combat the opioid crisis. Since declaring a public health emergency in 2017, our authorities have been pursuing a strategy comprised of the following elements: (1) improving access to treatment and recovery services; (2) promoting use of overdose-reversing drugs; (3) strengthening our understanding of the epidemic through better public health surveillance; (4) providing support for cutting edge research on pain and addiction; and (5) advancing better practices for pain management. We agree with staff that scaling up successful local level programs could be a promising way forward, and note that the Administration is seeking to use federal programs to drive progress forward.
External Sector and Trade. The U.S. current account deficit has been in the range of 2–2.5 percent of GDP in recent years, as services and income surpluses partially offset a larger deficit in traded goods. The evolution of the current account balance over the medium term will depend on global demand for U.S. exports and the strength of the U.S. economy, including the continuing effect of the recent tax reform measures on U.S. competitiveness.
The fundamental goal of our trade policies is to achieve free and fair trade globally. The Administration’s focus is on addressing unfair trade practices around the world that are impeding stronger and more balanced U.S. and global growth. To achieve balanced and fair trade, we must address the significant imbalances in global trade that stem in part from unfair trade policies and high trade barriers abroad. The President’s trade policies will set the stage for long-term economic growth, not only in the United States, but globally.
The Administration places high priority on securing Congressional passage of the United States-Mexico-Canada (USMCA) Trade Agreement, which will modernize these important trading relationships and promote growth throughout North America.
Monetary Policy. Our monetary authorities have stated that they will continue to execute U.S. monetary policy in a data-dependent manner, putting a premium on clear communication. In March 2019, the FOMC announced additional information on its plans for balance sheet normalization. Specifically, beginning in May, the Federal Reserve slowed the pace at which it is gradually reducing its holdings of Treasury securities, and the process of reducing the size of its balance sheet will conclude by the end of September. The Federal Reserve will continue to shift the composition of its balance sheet away from agency debt and mortgage-backed securities consistent with its longer run goal of primarily holding Treasury securities.
We recognize the importance of ensuring clear communication by the Federal Reserve, but IMF staff’s suggestions in this area may not help. In recent years, we have seen that the median projections from the Summary of Economic Projections (SEP) can be misinterpreted as a firm plan for policy, despite policymakers’ communications to the contrary. However, we are not convinced that publishing a consensus forecast in a quarterly monetary policy report would remedy this problem. In fact, such a report could reinforce this misinterpretation, even if the report highlights risks around a central scenario. In our view, the minutes of the FOMC meetings, including the SEP materials, already provide a great deal of information about the outlook and the attendant risks and uncertainties.
We appreciate staff’s positive findings on the timeliness of the Federal Reserve’s ongoing review of its monetary policy strategy, but question staff’s recommendation on the operating framework. IMF staff call for “a more holistic picture” of the evolution of the operating framework, but most of the key decisions about the operating framework have already been announced, and the remaining technical details may not be of importance to the broader public.
Financial Stability. We view financial stability risks as moderate and believe that our financial regulatory and supervisory institutions are responding appropriately to the evolution of risks. We agree with staff that U.S. banks are well capitalized and asset quality is generally good. We would not characterize financial conditions as being extremely loose, however. While term premia are near record lows, the spreads for a range of assets do not appear to us to be unusually narrow, nor is the VIX unusually low—particularly when using a longer time horizon than the past five years for comparison. The fundamental backdrop for the credit market is favorable and, while issuance of leveraged loans has grown, interest coverage ratios are generally in line with long-term trends and default rates remain quite low. Investor appetite for leveraged loans is within historical measures and shows no evidence of concentration issues. From our perspective, the post-crisis period has been marked by a gradual return to normal levels of risk appetite after the record level of risk aversion in the financial crisis period.
Nor do we believe that the tailoring changes made in recent years have inappropriately weakened standards. Recent tailoring of financial regulations has focused on better calibrating risk and compliance burden, especially for smaller, non-systemic financial institutions without diminishing the safety and soundness of the financial system. We believe that appropriately calibrated regulation is not mutually exclusive, nor inconsistent, with a prospering economy. The U.S. reforms maintain the key post-crisis reform efforts adopted for the largest and most complex banks: strengthened capital standards, robust supervisory regime –stress tests, stronger liquidity requirements, resolution planning, and a range of other enhanced prudential standards. The Federal Reserve’s stress testing (DFAST and CCAR) scenarios have been extremely tough in recent years, with several banks being forced to revise their capital plans.
We have made important steps to build resilience in non-banks and have seen improved liquidity risk management in funds. The SEC introduced new liquidity requirements in 2016 and stress testing for money market mutual funds as part of its 2014 money market mutual fund reforms. IMF staff’s recommendation that all asset managers be subject to liquidity provisions and stress testing is inconsistent with the aforementioned reforms and the business model of investment advisers, which generally act as agents and not as principals.
While there are concerns in the leveraged loan market, there are also mitigating factors, including the reduction of liquidity risks by the long lock-up periods of collateralized loan obligations (CLOs), significantly longer tenors compared to pre-crisis levels, and higher percentage of proportion of equity tranches for CLOs than pre-crisis. The Financial Stability Oversight Council (FSOC) has also provided an institutional mechanism to address the issue and coordinate among Council member agencies with supervisory or regulatory responsibilities, which continue to monitor the potential effects of developments in the leveraged lending market on their respective regulated entities and markets. The Federal Reserve, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency review and assess risk in leveraged lending, as well as other lending types, through their Shared National Credit (SNC) Program.
Moreover, the FSOC has issued proposed interpretive guidance that would prioritize an activities-based approach to addressing systemic risks to financial stability arising from nonbank financial companies rather than entity-based designations, using the latter only if identified risks cannot be appropriately addressed through an activities-based approach. Such an approach should more holistically address risks to financial stability and minimize the potential for competitive distortions in financial markets.
The bottom line is that the U.S. financial system is clearly stronger and much better positioned to withstand a shock or an economic downturn than it was before the crisis and that proposed regulatory reforms maintain the core protections for resilience in our banking and financial system. We look forward to more in-depth engagement with staff on financial sector issues through the Financial Stability Assessment Program (FSAP) for the United States, which is already underway.
Anti-Corruption. We value the IMF’s work on governance and anti-corruption and welcome the IMF’s analysis of the supply side of corruption in advanced economies, including the United States. We agree with staff on the importance of keeping the proceeds of foreign corruption out of the U.S. economy. We would underscore U.S. prosecutorial efforts and the use of sanctions designations and corruption-related advisories to communicate corruption-related risks and obligations to financial institutions, government, and non-governmental organizations. The Administration remains committed to working with Congress on legislation to strengthen the collection of beneficial ownership information.