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The International Monetary Fund warned that “downside risks” to the US economy had intensified, urging policy makers to take steps to boost recovery and avoid a “fiscal cliff” at the end of the year.

Christine Lagarde, IMF managing director, said a “failure to reach an agreement on tax and spending policies” was one of the main clouds hanging over the “tepid” US recovery. The so-called fiscal cliff, a combination of tax rises and spending cuts that could take effect at the end of the year, threatened to damage the domestic economy and have “significant spillover effects” around the world.

The IMF said the US remained “vulnerable to contagion” from the growing debt crisis in the eurozone, warning that financial stresses could be transmitted through a “generalised increase in risk aversion and lower asset prices”. It added that lower demand in Europe, and US dollar appreciation could hurt American exporters.

Domestically, if Congress does not take action before December 31, the US will suffer a fiscal contraction of $600bn – or roughly 4 per cent of gross domestic product – in 2013, which could plunge the country back into recession as scheduled tax increases and spending cuts take effect.

Republicans and Democrats are at odds over the solution to the fiscal impasse, with no obvious path to a deal until after the November election. However, fears are growing that it may also be hard to agree a deal late in the year and there are mounting concerns that uncertainty about the “fiscal cliff” could damage business and consumer confidence this year.

The IMF is recommending that the US should limit the contraction in its deficit as a percentage of GDP to 1 per cent next year, which would mean reversing much of the scheduled tightening.

The fund did not wade into the main source of political division on Capitol Hill: the fate of the Bush-era tax cuts for the wealthiest Americans. Democrats want to allow at least part of the cuts to expire but Republicans want to keep all of them. However, the IMF did recommend replacing scheduled automatic spending cuts to government programmes, including defence, with other reductions.

The IMF also argued for some short-term measures to stimulate the economy – including infrastructure spending, housing initiatives, training for the long-term unemployed and an extension of emergency jobless benefits.

It also urged Congress to increase the US borrowing limit, due to be reached early next year, to avoid a repeat of financial market stress that occurred last year before a possible default. But the IMF said it remained important for the US to produce a medium-term deficit reduction plan.

“We believe that fiscal consolidation is necessary but not any fiscal consolidation,” said Ms Lagarde. “It has to be sensible and certainly not excessive.”

The IMF said it expected the US economy to grow at 2 per cent this year, with a slight acceleration to 2.25 per cent in 2013, with unemployment falling very gradually from 8.2 per cent this year to 7.9 per cent in 2013. The fund said monetary policy could still play a role in aiding the economy, welcoming the Federal Reserve’s decision last month to extend “Operation Twist” through the end of the year and noting that more moves by the US central bank could be needed if economic conditions kept worsening.

Ben Bernanke, Fed chairman, has also warned lawmakers to act to prevent the “fiscal cliff”, as has the Institute for International Finance, which represents several hundred of the largest global financial institutions.

Copyright The Financial Times Limited 2017. All rights reserved.

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