IMF says US faces hard balancing act

The International Monetary Fund warned the Federal Reserve has a difficult balancing act ahead to avoid a recession.

“An overly forceful policy response runs the risk of triggering an abrupt tightening in financial conditions and a US recession, creating negative spillovers to the global economy,” said the IMF. Alan Blinder, a former Fed vice-chair, tells Central Banking he expects it to raise rates to their neutral level before deciding on further tightening.

The IMF cut its previous GDP growth estimate for the US this year to 2.3%, from its forecast of 2.9% in June and 3.7% earlier. It said US inflation could cause serious spillover effects for the global economy.

Fed chair Jerome Powell acknowledged the possibility of a recession in late June but said he does not expect one. Regional Fed presidents Charles Evans, James Bullard, and James Williams all expect the US will avoid a recession. The IMF’s base scenario is slower growth without a precipitating recession as well.

The Atlanta Fed satellite’s real-time GDP tracker and predictor estimates GDP will be -1.2% in the second quarter for the US. If the prediction comes to pass, it would be the second quarter in a row of negative GDP and, in many definitions, thus begin a recession.

“Avoiding a recession in the US is becoming increasingly challenging,” said the IMF directors.

The IMF directors welcomed the Fed’s June decision to raise rates by 75 basis points and issue forward guidance on future rises. They recommended the Fed raise the interest rate above neutral and “keep it there for some time.”

“My guess is that the Fed will cease raising rates after it passes neutral, and then wait to see what happens,” Blinder says.

Fed governors generally estimate the neutral interest rate, the level that does not stimulate or restrict economic growth, to be between 2% and 3%. Blinder says inflation reaching between 2% and 3% in the next two to three years “seems reasonable”.

Robert Dekle, a professor of finance at the University of Southern California, says inflation will likely lower towards the Fed’s 2% target in the next three years. But he warns it is likely the US will suffer a “serious recession”.

Commentators have questioned the extent to which inflation is transitory. The median expectation from Federal Open Markets Committee participants puts inflation close to 2% by 2024.

“I’ve stopped using the word [transitory to describe inflation], since ‘transitory’ is taking longer than many of us thought,” says Blinder. “But the essence of the idea remains valid: many of the causes of today’s high inflation – Covid-related supply problems, oil prices, food prices – will naturally fade away with time.”

The IMF also said unpassed measures in US president Joe Biden’s legislative agenda would help to reduce supply pressures causing inflation. The directors encouraged lowering tariffs and trade restrictions imposed during the previous presidency.

They also recommended a number of measures aimed at reducing carbon emissions and mitigating the effect of climate change. These included “broad-based pricing of carbon and other pollutants”.

The IMF directors said US wage and price growth are unlikely to cause a feedback spiral. “The evidence suggests a relatively weak feedback loop between wages and retail prices in the US. The passthrough from wages to prices has tended to be low and concentrated in services,” said the report.