The financial markets’ assessment is that the Federal Reserve will not wait too long after it’s monthly asset purchase program ends before tightening monetary policy, but “we’re not that certain about the short order,” IMF Managing Director Christine Lagarde said Monday.
Speaking at a press conference following the release of the International Monetary Fund’s Article IV consultation with the United States, Lagarde cautioned against a premature tightening of policy, while predicting economic growth will be much better after the disappointment of the first quarter contraction in activity.
On the timing of the first interest rate hike, given the IMF’s forecasts for job growth and unemployment, the uncertainty surrounding those numbers, and the expectation that inflation will be below the Federal Open Market Committee’s 2% target for some time, “we don’t see that short order to be March 2015, let’s put it that way,” she said.
For comparison purposes, Lagarde pointed out the recovery in the United States is not as strong as the rebound in UK economic growth.
So while the IMF does not have a fixed date for when it expects the Fed to begin raising interest rates, “we don’t think it will necessarily be in short order” after the central bank is done tapering its asset purchases, she reiterated.
Lagarde also counseled against raising interest rates sooner than necessary, as that could negatively impact the pace of the recovery “and would not be positive from an employment point of view.”
A premature tightening of U.S. monetary policy could also have more severe consequences for the global economy, where the spillover to emerging market countries would harm their growth, she added.
She did warn the very low interest rate environment means financial stability risks have not gone away, but instead have built up during the “protracted period” of highly accommodative monetary policy.
“The current conjecture of very low market volatility creates also the potential for an abrupt shift in financial markets,” Lagarde said, adding regulators must closely monitor the shadow banking system and other non-bank intermediaries. “We recommend conscientious overnight and a proactive approach,” she said.
The IMF revised down its 2014 growth forecast for the United States to 2% from the 2.8% it projected in April, an action that is largely the result of weak economic activity in Q1 due to bad weather, Lagarde said.
She assured that the IMF believes “the slowdown is temporary, and better prospects lie ahead,” with growth in the coming quarters expected to be “a lot stronger” at 3% or possibly higher.
There remain risks to the outlook, Lagarde warned, noting weaknesses in business investment and the housing market that could continue to be drags on growth in the future.
So the Fed’s path of gradual monetary policy normalization is the right approach, she said, noting the IMF’s forecast that the United States economy will only reach full employment at the end of 2017, while inflationary pressures remain muted.
Lagarde call on U.S. policymakers to invest in the country’s future, saying the priority is to invest in people as well as infrastructure to boost productivity and “try to get people back in the labor force.”
She also said the country should take additional measures to “mitigate inequalities,” voicing support for raising the minimum wage.
Despite the progress the Obama administration and Congress have exhibited on budget issues, Lagarde again noted “it remains critically important” for the U.S. to adopt and implement a credible medium-term plan to bring down government debt and “secure sustainability.”
“Provided there is this medium-term fiscal plan, we see room for some targeted fiscal support today to help lay the foundation for higher growth tomorrow,” she added.
In the long run, the country must get to grips with the long-term drivers of rising debt, Lagarde said, including controlling healthcare costs, reforming Social Security, as well as improving a tax system that is too complex and generates “too little revenue.”
“Attention must now turn to the kinds of policies needed to lay the foundation for growth that will be sustainable,” she said.