IMF Warns of Global Threat of Inflation : U.S. Urged to Take Steps to Cut Deficit, Possibly Hike Taxes

The powerful global economic expansion, now in its seventh year, will be in jeopardy unless inflation is controlled and trade imbalances are reduced, the International Monetary Fund said today.

Although the rise in interest rates in the last year could upset currency markets, increase the burden of Third World debt and hinder growth in developing countries, the fund said more harsh medicine might be needed.

“The tightening of monetary conditions during 1988 has helped to reduce the danger of a significant pick-up in inflation during the period ahead. However, policy makers should be prepared to take additional steps should inflation fail to moderate as envisaged,” the fund’s staff said in its semiannual World Economic Outlook.

The report was released as the fund’s policy-making Interim Committee met to discuss the economy and new U.S. proposals for reducing Third World debt.

Harsh Consequences

The fund said the harsh consequences of higher interest rates might be avoided if the United States takes urgent steps to cut its huge budget deficit, if necessary by raising taxes.

It said the Bush Administration’s deficit forecasts are optimistic and warned that it might not fall much in the medium term unless new deficit-reduction measures are taken.

In a somber analysis, the fund said the deficit in the U.S. current account, the broadest measure of trade, probably will widen from $135.3 billion in 1988 to $139.3 billion this year and $156.6 billion in 1990.

The mirror-image surpluses of Japan and West Germany will grow at the same time, the fund said.

“On the basis of current policies and exchange rates, these imbalances are likely to remain large into the 1990s, which would involve a significant risk of instability in financial markets, accompanied by higher inflation and a slowdown in growth,” the report added.

Violent Reaction

The risk is that foreign investors might refuse at some point to keep financing the U.S. deficit unless they can buy dollars more cheaply or get higher interest rates on the money they lend. If they were to refuse, the market reaction could be so violent as to endanger economic growth, the fund said.

After expanding a surprisingly strong 4.1% in 1988, the main industrial countries were projected to grow 3.3% this year and 2.9% in 1990.

Inflation is expected to pick up to 3.8% from 3.2% in 1988 before slowing to 3.5% in 1990 as a result of the recent rise in interest rates.

The fund said, however, that there is a risk that inflation could be higher, and officials said the fund recently revised its estimate of U.S. inflation upward because of rising oil prices and higher consumer prices in early 1989.