A sudden rise in U.S. inflation could pose serious risks to global financial markets if the Federal Reserve were forced to respond quickly, the International Monetary Fund said.
A U.S. unemployment rate of 3.8%, the lowest in 50 years, suggests that the country "is beyond full employment," the IMF said in a July 3 executive board report. The statement follows last month's staff report on the organization's Article IV consultation with the U.S.
The recent package of U.S. tax cuts and increased government spending, especially on defense, is expected to increase the budget deficit to 4.6% of GDP by next year, the IMF said. At this stage of the business cycle, that expansion could trigger a "faster-than-expected rise in inflation ... accompanied by a more rapid rise in interest rates that could increase market volatility both in the U.S. and abroad," it added.
Capital flows could reverse, especially in vulnerable emerging market economies, the international lender warned, leading to a rise in global imbalances. "These risks are added to by recent actions by the U.S. to impose tariffs on imports," it said.
IMF directors specifically called out U.S. protectionist trade policies as presenting risks to the country's economy and beyond.
U.S. tariffs threatened or already imposed by the administration could cause "damaging effects beyond the U.S. economy, trigger retaliatory responses, and undermine the open, fair, rules-based multilateral trading system," the report said.