WASHINGTON — The International Monetary Fund Wednesday urged the Bush administration to develop a plan to balance the federal budget, saying tax cuts had given the economy only a modest lift, and warning that widening fiscal deficits held dangers for domestic and global growth.
U.S. policymakers will need both tax increases and spending restraint to balance the budget, the global lender said in a report, which it described as part of an annual review of the U.S. economy.
"The deficit will be reduced by the cyclical expansion that is now under way, which will absorb spare capacity in the economy. But even assuming tight spending limits and a sharp rebound in revenues, this would still leave a deficit of around 2% of GDP with the economy operating at full capacity," Charles Collyns, deputy director of the IMF's Western Hemisphere Department, told reporters.
"How to deal with this structural deficit undoubtedly will require both tax and spending initiatives," he added.
The global lender said that balancing the budget was crucial to avoid a rise in interest rates that posed significant risks for the United States and the rest of the world.
"With budget projections showing large federal fiscal deficits over the next decade, the recent emphasis on cutting taxes, boosting defense and security outlays, and spurring an economic recovery, may come at the eventual cost of upward pressure on interest rates, a crowding out of private investment, and an erosion of longer-term U.S. productivity growth," the IMF report said.
The fund also warned of the dangers of a growing and record shortfall in the U.S. current account -- the broadest measure of American trade with the rest of the world -- which it said could spoil foreign investors' appetite for U.S. assets and cause the dollar to weaken further.
The dollar has been falling for weeks against major currencies, reaching record lows against the euro and a three-year low against the Japanese yen.
The fund said the decline of the dollar had been "fairly orderly" but had complicated economic policy management in the euro area and in Japan.
"Although the dollar's adjustment could occur gradually over an extended period, the possible global risk of a disorderly exchange rate adjustment, especially to financial markets, cannot be ignored," the IMF warned.