The International Monetary Fund cut its growth forecast for the U.S. economy this year and said the Federal Reserve may have scope to keep interest rates at zero for longer than investors expect.
The Washington-based IMF now sees the world’s largest economy growing 2% this year, down from an April estimate of 2.8%. The IMF left a 2015 prediction unchanged at 3%, and said it doesn’t expect the U.S. to see full employment until the end of 2017, amid low inflation.
“Momentum faded in the U.S. economy” early this year as a harsh winter “conspired with other factors” such as a drawdown in inventories, a sluggish housing market and slower demand, IMF economists wrote. While a rebound is under way, it’s providing “only a partial offset” to the weakness that led to a contraction in the first quarter, they wrote.
The IMF also said it foresees longer-run potential growth averaging around 2% for the next several years, below historical averages and less than last year’s estimate. A year ago, the IMF projected potential growth rates at 2.3% in 2015-2016 and 2.4% in 2017-2018.
For the Fed, the forecast means “policy rates could afford to stay at zero for longer than the mid-2015 date currently foreseen by markets,” the fund said in its annual assessment of the U.S. economy.
Should inflation rise more than expected with the economy below full employment, “tolerating a modest, temporary rise of inflation above the longer-term goal could be consistent with the Fed’s balanced approach as long as inflation expectations remain anchored and financial stability risks were low,” the IMF said.
The IMF forecast comes less than a week after the World Bank reduced its 2014 growth forecast for the U.S., to 2.1% from 2.8%. Private economists have also lowered their forecasts this month. The median forecast in a Bloomberg survey of 84 economists this month calls for growth of 2.2% this year, down from a May projection of 2.5%.
Fund economists urged the U.S. to raise the minimum wage, invest in infrastructure and overhaul immigration policies to boost potential growth as it slips below the long-term average.
The IMF offered its advice two days before the Fed meets in Washington. Fed Chair Janet Yellen will hold a press conference on June 18, after the Federal Open Market Committee, which guides monetary policy, concludes a two-day meeting.
The U.S. central bank in April decided to trim its monthly bond-buying program by $10 billion to $45 billion. It is expected to continue the tapering its bond-buying effort until late this year as part of the wind-down of a third quantitative easing program.
The Fed has to contend with “multiple areas of uncertainty,” making the outlook for its policy “particularly uncertain,” according to the IMF. That is “in contrast to the narrow range of market views on the path for future policy rates as well as the current historically low pricing of asset price volatility.”
Even if the Fed communicates well its planned increase in interest rates, there’s still a risk for “significant swings in market flows and prices” in coming months, including beyond U.S. borders, the IMF said.
The report suggests additions to the Fed’s communication tool kit, including a press conference after every meeting of the Federal Open Market Committee and a quarterly monetary report with details about the view of FOMC’s majority.
The IMF also urged the implementation of more proactive labor market policies, which included strengthening the Earned Income Tax Credit and increasing the minimum wage to align more closely with U.S. historical levels and international standards.
“This would help raise incomes for millions of working poor and would have strong complementarities with the suggested improvements in the EITC,” said the report.
President Barack Obama announced an executive order in February that would raise the federal minimum wage level to $10.10 an hour from $7.25. In April, U.S. Senate Republicans blocked the legislation.