US deficit poses ‘significant risks’ to global economy, IMF warns

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US deficit poses ‘significant risks’ to global economy, IMF warns

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The IMF has warned the United States that its massive budget deficits have fueled inflation and pose “significant risks” to the global economy.

The fund said in its benchmark Fiscal Monitor report that it expected the United States to run a budget deficit of 7.1 percent next year, more than three times the average of 2 percent. other advanced economies.

It has also raised concerns about China’s public debt, with the country expected to post a deficit of 7.6 percent in 2025 – more than double the 3.7 percent average of other emerging markets – as Beijing faces low demand and a housing crisis.

The United States and China are among four countries cited by the fund that “need to take policy action to address fundamental imbalances between spending and income.” The other countries were the United Kingdom and Italy.

Rampant spending by the United States and China in particular could “have profound effects on the global economy and pose significant risks to baseline fiscal projections in other economies,” the IMF said.

The assessment comes as economists and investors increasingly fear that 2025 will be a critical year for U.S. fiscal policy.

Presumptive Republican presidential nominee Donald Trump has pledged to make his 2017 tax cuts permanent, a move that the think tank Committee for a Responsible Federal Budget expects to cost the country $5 trillion. over the next decade. Democrats have been accused by Republicans and economists of not doing enough to reduce “discretionary spending” on Health and Social Security.

On Tuesday, the IMF’s chief economist, Pierre-Olivier Gourinchas, said the U.S. fiscal situation was “particularly worrying,” suggesting it could complicate the Federal Reserve’s attempts to return inflation to its target. 2 percent target.

“This raises short-term risks to the disinflation process, as well as long-term risks to the fiscal and financial stability of the global economy,” he said. “Something will have to give.”

The public debt burden rose following high spending at the start of the pandemic and a sharp rise in global borrowing costs as central banks sought to tame the worst surge in inflation in decades.

The Congressional Budget Office said the U.S. federal debt stood at $26.2 billion, or 97 percent of gross domestic product, at the end of last year. The independent budget watchdog expects this rate to reach the previous record of 116% recorded after World War II in 2029.

Line chart of government debt as a % of GDP, with IMF forecasts showing US government debt expected to increase significantly

In other advanced economies, such as the eurozone, budget deficits have been reduced in 2023.

But the IMF said the United States had experienced “remarkably large fiscal slippages,” with the budget deficit reaching 8.8% of GDP last year, more than double the 4.1% deficit recorded for 2022. .

The IMF said the country’s budget deficit contributed 0.5 percentage points to core inflation – a measure of underlying price pressures that excludes energy and food. That means U.S. interest rates would need to stay high longer to bring inflation back to the Fed’s 2 percent target.

The CBO already estimates that the bill for net interest payments to holders of U.S. debt will reach $1 trillion after 2026.

The IMF noted that “large and sudden increases” in U.S. borrowing costs typically lead to rises in government bond yields around the world and exchange rate turbulence in emerging and developing economies.

A fund analysis found that a 1 percentage point rise in U.S. rates led to a 90 basis point rise in other advanced economies and a 1 percentage point rise in emerging markets.

“The spillover from global interest rates could contribute to a tightening of financial conditions, increasing risks elsewhere,” the IMF said.

He adds that Chinese government debt, unlike U.S. Treasuries, tends to be held domestically, so a sharp rise is not expected to impact global markets in the same way. But the fund believes that the country’s debt dynamics could still weigh on its trading partners.

“A larger-than-expected slowdown in growth in China, potentially exacerbated by unintended fiscal tightening given significant budgetary imbalances within local governments, could generate negative spillover effects on the rest of the world through lower trade levels international, external financing and investments. “It said.

The IMF’s top fiscal policy official, Vítor Gaspar, said the economic power of the United States and China meant they had time to regain control of their finances. Both governments had greater fiscal space than their counterparts, giving them “more room to correct and control”, he said.

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