IMF warns of severe economic shock if US fails to lift debt ceiling

The U.S. should raise its $14.3 trillion debt ceiling to avoid “a severe shock” to the global economy, the International Monetary Fund (IMF) has warned.

In an annual report card on U.S. economic policy made public on Wednesday, the IMF said the debt ceiling should be raised as soon as possible to avoid damage to the economy and world financial markets.

The warning in the report, which was sent to the U.S. government on June 20, comes at a turning point for negotiations on raising the debt ceiling. Talks led by Vice President Biden hit an impasse last week over GOP objections to including any raised tax revenue in a deal to reduce deficits. 

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Treasury has set an Aug. 2 deadline for raising the limit, warning it will then no longer be able to pay the nation's bills. Speaker John Boehner (R-Ohio) on Tuesday said this was an artificial deadline, suggesting it could be extended. 

For the IMF, the “major policy challenge” for the U.S. is to deal with the federal debt without hurting the “still-fragile” economic recovery.

Failure to raise the debt ceiling "soon enough," along with too quick a cut in spending, is listed in the report as one of five increasing risks to the U.S. economy. The others are continued housing market weakness, commodity price spikes, tight credit supply and spillover from European debt problems.

The report criticizes President Obama’s budget both for failing to achieve sufficient medium-term deficit reduction and for cutting too much too soon. The IMF also chides the administration for using overly rosy growth estimates in its budgeting.

“The deficit reduction proposed in the February budget could be too front-loaded given the cyclical weakness and, at the same time, insufficient to stabilize the debt by mid-decade,” the report states.

It endorses discretionary spending caps, a proposal favored by the GOP, and a “failsafe” trigger that would ensure that the size of the debt relative to the economy is shrinking, an idea proposed by the White House that could allow for tax increases.

The IMF is more cautious than the Federal Reserve in predicting economic growth this year.

The IMF estimates U.S. gross domestic product will grow by 2.5 percent in 2011 and 2.75 percent in 2012.

The Fed last week downgraded its outlook on U.S. growth for the year to 2.7 to 2.9 percent. In April, it had predicted growth of 3.1 to 3.3 percent.

The IMF report contains a wealth of other advice for the U.S. It urges complete implementation of the Dodd-Frank financial reforms and says Congress should provide enough funds to do so and resist watering the reforms down.

It says implementation of the reforms, if paired with “clarity on the scope of the final rules,” should “help revive investor demand.”

For the Fed, the IMF says the current policy of low interest rates will likely remain appropriate “for some time.” It backs the end of the quantitative easing policy of buying U.S. treasuries, and recommends a “gradual path” for selling off the bond holdings.

The IMF recommends increased spending in one areas: job training. It also suggests the government consolidate 50 different job programs.

To raise more revenue, the IMF suggests the U.S. consider a national sales tax known as a value-added tax or a carbon tax. Neither of those proposals is likely to be picked up by Congress.

The report was given to the government on June 20 but was released Wednesday.