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IMF urges repeal of 'ill-designed' U.S. cuts

A view shows the Federal Reserve building in Washington August 22, 2012. REUTERS/Larry Downing
A view shows the Federal Reserve building in Washington August 22, 2012. REUTERS/Larry Downing

By Anna Yukhananov

WASHINGTON (Reuters) - The International Monetary Fund urged the United States on Friday to repeal sweeping government spending cuts and recommended that the Federal Reserve continue a bond-buying program through at least the end of the year.

In its annual check of the health of the U.S. economy, the IMF forecast economic growth would be a sluggish 1.9 percent this year. The IMF estimates growth would be as much as 1.75 percentage points higher if not for a rush to cut the government's budget deficit.

The IMF cut its outlook for economic growth in 2014 to 2.7 percent, below its 3 percent forecast published in April. The Fund said in April it still assumed the deep government spending cuts would be repealed, but it had now dropped that assumption.

Washington slashed the federal budget in March, adding to the drag on the economy created by tax increases enacted in January.

The IMF said the United States should reverse the spending cuts and instead adopt a plan to slow the growth in spending on government-funded health care and pensions, known as "entitlements." The Fund would also like the United States to collect more in taxes.

"The deficit reduction in 2013 has been excessively rapid and ill-designed," the IMF said. "These cuts should be replaced with a back-loaded mix of entitlement savings and new revenues."

The IMF warned cuts to education, science and infrastructure spending could reduce potential growth.

While the Fund said total debt across all levels of government would likely decline after 2015, public finances are nevertheless on an unsustainable path due to an aging population and higher spending on health care.

"Now our advice is not just to slow down (budget cuts)," IMF Managing Director Christine Lagarde said at a news conference. "Our advice is also to hurry up: hurry up with putting in place a medium-term road map to restore long-run fiscal sustainability."

She said effects of higher spending on health care and other programs build up over time, so it was important to act quickly to address them.

KEEP EASING FOR NOW

The Fund recommended that the U.S. Federal Reserve keep up its massive asset purchases at least through the end of the year to support the U.S. recovery, but should also prepare for a pull-back in the future.

The Fed is currently buying $85 billion per month of Treasuries and mortgage-backed securities in an effort to lower borrowing costs and spur employment growth. Lagarde said the IMF has assumed that the Fed would begin trimming bond purchases next year.

Speculation over when the Fed might start to pare back its bond buying has roiled financial markets recently. Fed Chairman Ben Bernanke stoked market speculation last month when he said a decision to pare the Fed's current pace of asset purchases might happen at one of the Fed's "next few meetings" if the economy looked set to maintain momentum.

Recent outflows from bond funds and the rise in volatility offer a worrying glimpse of how markets are likely to behave as the Fed works to scale back its enormous monetary stimulus.

The IMF said unwinding the easy-money policies would likely present challenges, and it was key for the Fed to communicate effectively with markets.

It also said the long period of low interest rates could have unintended consequences in the future, sowing the seeds of future financial vulnerabilities.

(Additional reporting by Jason Lange; Editing by Andrea Ricci and Andre Grenon)

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