The International Monetary Fund on Thursday urged the United States to quickly reach an agreement on a permanent fix to avoid automatic tax hikes and spending cuts due to start next year, saying a stop-gap solution could be harmful to the global economy.
Many analysts believe Washington will come up with a deal that would temporarily stave off what has become known as the fiscal cliff, although doubts persist as to whether Congress can agree on a timely compromise.
In a report prepared for the Group of 20 finance ministers' meeting in Mexico on Nov. 4-5 and published on Thursday, the IMF warned that the eurozone crisis and the threat of a political impasse in Washington over the fiscal cliff posed the biggest risks to the world economy.
The combined $600 billion in U.S. government spending cuts and tax rises due to be implemented under existing law in early 2013 are seen by many as threatening to tip the economy back into recession.
"A last-minute deal that relies on suboptimal fixes or largely 'kicks the can down the road' may ultimately prove harmful," the IMF said in the report.
Dealing with the fiscal cliff is the biggest near-term challenge facing the Obama administration. It is also one of the biggest concerns for international policymakers, with Canada warning this week it could fall into recession if Washington does reach a deal on fiscal consolidation.
The IMF said the U.S. economy could fall back into recession if Congress fails to avert the package of tax hikes and spending cuts.
The IMF said the severity of the impact of a large fiscal contraction in the United States "would partly depend on the duration of the cliff."
The IMF also urged Washington to agree on a credible plan to reduce government debt, warning that failing to do so could "exacerbate uncertainty," and could "lead to a gradual erosion of the reserve currency status of the U.S. dollar and put upward pressure on Treasury bond yields."
While some progress has been made in addressing the eurozone crisis, the IMF urged Europe to present a road map for banking union followed quickly by implementation.
It also said eurozone countries facing high borrowing costs should implement fiscal adjustment plans and if needed request financial support from European emergency funds.
Spain is currently considering whether to ask for aid from the euro zone. Promises of help from the EU and the European Central Bank have brought Spain's borrowing costs down from unsustainable levels in the past few months.
The IMF said austerity in periphery countries in the euro zone risks becoming politically and socially untenable. Countries like Greece, Portugal and Ireland are currently implementing IMF-EU supervised austerity packages in return for international aid.
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