–‘There Is Clearly Scope’ For Additional Fed Action
–Housing Recovery To Cause US Growth To Accelerate Down The Road

By Brai Odion-Esene

WASHINGTON (MNI) – A senior International Monetary Fund official
Thursday warned of the heavy toll that the looming fiscal cliff would
take on the U.s. and global economy, describing it as a “very bad”
outcome that should be avoided.

Roberto Cardarelli, division chief in the IMF’s Western Hemisphere
Department, told reporters during a conference call to discuss the
Article IV report on the U.S. that the Fed has more scope to ease
monetary conditions, and that the housing market is headed in an upward
direction.

On the fiscal cliff, Cardarelli said an actual materialization of
the combined tax increases and spending cuts would result in over 4% of
GDP in fiscal adjustment, “literally unprecedented in terms of size.”

“And it would occur at a moment when the U.S. economy is weak, and
where other tools to cushion the impact of that adjustment — typically
monetary policy — are less effective because you don’t have much scope
to cut interest rates,” he said.

The fiscal cliff, he continued, would cause GDP growth to turn
negative early in 2013 and coming out of that, “a year with a potential
recession or no growth at all.”

Cardarelli said the potential ramifications could be quite
negative, with a huge loss of confidence — reflected in stock markets
declining — and spillovers immediately to trading partners like Mexico
and Canada.

Given the size of the U.S. economy, if it were to see no growth or
contract next year, “you are inflicting a very sizable shock to the
world economy,” he said.

“It’s a very bad outcome for the U.S. economy, it’s a very bad
outcome for the world … . It should be avoided,” Cardarelli added.

The U.S. government is also expected to hit the debt limit at the
end of this year, requiring Congress to raise it yet again, and
Cardarelli stressed it is “imperative to do that in advance” to minimize
the potential for financial market disruption.

Harking back to the plunge in business and household confidence
last year during the debt impasse, he said such brinksmanship is
something “that can easily be avoided and needs to be avoided.”

Cardarelli also underlined the importance of U.S. authorities
addressing the nation’s fiscal issues in the medium term.

He warned that should the U.S. fiscal outlook continue to remain
very unfavorable, with no attempts to craft a credible plan, then
“sooner or later” there will be a response in the bond markets.

While this would not happen in the short term, given the “very
unsettled” situation elsewhere and weak growth prospects, it is
certainly a risk looking ahead, he said.

The Article IV report argued that U.S. monetary policy will need to
remain highly accommodative for quite some time,” with further easing
should the outlook deteriorate.

“There is clearly scope for action,” Cardarelli said, citing an
inflation rate that is below target and an unemployment rate that
remains stubbornly high.

He noted the slowdown in second quarter growth but said it is not
yet clear if it is a temporary soft patch or a sign of persistent
weakness taking hold.

He listed the options Fed officials have said the central bank
could implement to bolster the recovery, including another large scale
asset purchase program.

Cardarelli did not declare a preference for any particular
measures, just noting that the Fed could buy mortgage-backed securities
given the impact it would have on mortgage rates. And if the Fed chose
to again purchase just U.S. Treasury securities, that would encourage
investors towards buying more riskier assets.

Still, “they are clumsy tools,” he said, adding, “this is clearly
one the reasons that they are deployed with utmost care,” given their
likely impact remains uncertain.

Cardarelli had some glowing reviews for the U.S. housing sector,
noting it is among the few bright spots in the outlook.

He said that while house prices are still below what they should
be, the Obama administrations housing measures — such as expanding the
loan modification and refinancing programs — are having some effect.

“The direction is clearly upward,” he said, and predicted that
housing will add to growth over the few next years.

“Over the next few years, the formation of U.S. households and the
depreciation of the housing stock will imply that there will be need for
about 1.5 million homes to be built on a yearly basis,” Cardarelli said.

He stressed that while this might not happen right away, it is
likely to happen over a period of three, four or five years.

He added that with the pace of construction activity at the moment
barely above 700,000, there is quite a bit of scope for a strong pickup
in construction once the existing inventory of foreclosed properties are
absorbed.

“That is clearly something that is going to help U.S. growth over
the medium term,” Cardarelli said, especially given the positive
implications that the housing market has for household balance sheets,
for confidence and demand in other sectors.

** MNI Washington Bureau: 202-371-2121 **

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