IMF PREDICTS SLOW, RISKY U.S. RECOVERY

by Abid Aslam

(IPS) WASHINGTON -- The International Monetary Fund (IMF) has upgraded its expectations of the world's largest economy, saying the U.S. will end this year with no economic growth before starting a gradual recovery in 2009.

Soaring commodity prices cloud the outlook, however, even as rising unemployment and budget pressures undermine U.S. policymakers' ability to respond to upsets.

The IMF, following annual consultations with U.S. officials, said in a summary released Friday that it expected growth to be "roughly flat" in 2008 and to rise to around 2 percent next year. In April, the agency had predicted 0.9 percent growth in 2009.

"The slowdown in the U.S. has been less than feared, and a recovery should begin next year as important headwinds are overcome," the fund said. "A more rapid recovery is clearly possible given the substantial policy stimulus and proactive response of financial markets to repair balance sheets."

IMF economists nevertheless acknowledged that the United States had dragged other economies down with it. During the second half of this year, all the major industrial economies would post slower-than-average growth for the first time in nearly a decade.

They further cautioned that the U.S. recovery remains under threat from poor household and bank finances and from rocketing energy and food prices.

The fund appeared to mimic the U.S. central bank in downgrading risks of a pronounced recession and in urging vigilance against inflation. Rising costs sap consumer spending, which generates roughly two-thirds of national economic output.

"Monetary policy settings are now broadly supportive of recovery and a risk-management approach would suggest that policy should be on hold," the fund said. It referred to action by the Federal Reserve, which has cut benchmark interest rates by 3.25 percentage points, to 2 percent, since last September. This in order to prevent crises in the housing and credit markets from pulling the economy into a deep recession.

"Vigilance will be required, given the stimulus in the pipeline and the imperative of keeping inflation expectations well in check," the IMF added Friday.

A Reuters/University of Michigan poll last week revealed that consumers anticipate an annual inflation rate of 3.4 percent in the coming five years, the highest level since 1995. Numerous surveys in recent months have shown consumer confidence at their lowest levels in three decades.

The fund's latest assessment came ahead of a Jun. 24-25 meeting of the U.S. central bank's rate-setting Federal Open Market Committee. Investors, taking their cue from recent statements by Fed Chairman Ben Bernanke, expect the committee to hold rates steady for the time being after cutting them seven times over the past 10 months.

Lower interest rates stoke inflation. Oil and gold prices rise by more than 1 percent for every 1 percent drop in the value of the dollar, according to the IMF. The Dallas Federal Reserve, a regional branch of the central bank, has blamed the weaker dollar for about one-third of the 60-dollar increase in oil prices between 2003 and 2007. The already weak U.S. currency dollar has fallen faster since the Fed began cutting rates.

The IMF said the Fed's ability to combat inflation by raising interest rates would be constrained by rising unemployment. On the other hand, it added, the massive U.S. budget deficit limits the government's capacity to further stimulate the economy.

U.S. officials have played down the likelihood of full-blown stagflation, characterized by inflation amid economic stagnation, but the term has gained renewed currency because rising commodity prices and a weak dollar have brought inflationary pressure to bear on the U.S. economy even as the credit crunch and housing slump have stalled it.

If further action proves necessary, fund economists said, it should target "the housing and financial sectors at the root of the current problems."

They cautioned against moral hazard, or the argument that government bailouts of reckless borrowers and investors encourage further risk-taking, but added that a Democratic legislative proposal to promote mortgage write-downs "warrants consideration."

Write-downs enable troubled borrowers to have the outstanding balance on their mortgages reduced in line with declining housing prices so they are not saddled with a debt greater than the market value of the underlying asset -- in this case, their home.

"The [Bush] administration has supported measures encouraging lenders to avoid foreclosures by modifying loans for borrowers in difficulty," the IMF statement said. "Policies need to be mindful of moral hazard but further action to limit avoidable foreclosures is justified by risks that house prices could fall below equilibrium."