The US budget deficit could trigger an upsurge of inflation and interest rates that shakes financial markets, according to a report by the International Monetary Fund.
In a statement following its regular Article IV assessment of the US, the fund’s staff said the Republicans’ $1.5tn tax-cutting package, coupled with a $300bn spending boost, will drive the federal budget deficit to 4.5% of gross domestic product by 2019, nearly double the level three years ago.
The rapidly rising gap in the public finances will provide a near-term boost to the US economy and those of some trading partners, but it entails a host of risks for the world economy. Among those is the possibility of faster-than-expected inflation, which could force the Federal Reserve to lift rates more quickly than markets have been anticipating, the FT reported.
"That would be accompanied by a more rapid rise in interest rates that could increase financial market volatility both in the US and abroad," IMF’s managing director Christine Lagarde said at a press conference. She warned that symptoms of those negative effects were already materialising in emerging markets.
The US is on course for 2.9% GDP growth this year and 2.7 per cent in 2019, according to the IMF’s forecasts, thanks in part to the scale of the fiscal stimulus. Growth will quickly stumble, however, dropping to 1.9% in 2020 and then 1.7% in 2021. While the Trump administration has predicted tax cuts will deliver a long-term boost to the economy’s growth potential, the IMF differed, saying potential growth will return to its long-term trend of 1.75% as soon as 2021.
In response to the report, the Treasury said it differed “significantly” over medium- and long-term growth projections. The Treasury secretary Steven Mnuchin said that he views the fund’s medium-term outlook as too pessimistic.
In addition, the shift towards greater protectionism being advocated by US President Donald Trump could move the world away from an open and rules-based trading system, the fund said, with adverse effects both for the US economy and for its partners.