IMF Raises Concerns about Potential Inflation Risks and Excessive Government Spending

The International Monetary Fund (IMF) issued a warning about a jump in upside risks to inflation, driven by elevated service-sector costs and exacerbated by too much government spending and the forces of deglobalization, which could prompt the U.S. central bank to hold interest rates higher for longer and so dim prospects for a soft landing.

“The good news is that, as headline shocks receded, inflation came down without a recession,” Mr. Gourinchas wrote in the blog post. “The bad news is that energy and food price inflation are now almost back to prepandemic levels in many countries, while overall inflation is not.”

The IMF predicts that inflation across the world, including in the United States, will decelerate more slowly in the latter half of the year, mostly due to rising services prices.

“Services inflation is holding up progress on disinflation, which is complicating monetary policy normalization,” the IMF said in the report overview. “Upside risks to inflation have thus increased, raising the prospect of higher for even longer interest rates, in the context of escalating trade tensions and increased policy uncertainty.”

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Higher-for-longer interest rates, in turn, increase external, fiscal, and financial risks, raising the likelihood of a recession.

“We project global inflation will slow to 5.9 percent this year from 6.7 percent last year, broadly on track for a soft landing,” Mr. Gourinchas wrote. “But in some advanced economies, especially the United States, progress on disinflation has slowed, and risks are to the upside.”

The elevated upside inflation risk comes at a time when the U.S. economy is showing increasing signs of cooling, especially in the labor market, Mr. Gourinchas noted.

Part of what’s driving up service wages is that goods prices remain high relative to services, making services comparatively cheaper and increasing their relative demand, Mr. Gourinchas wrote in the blog post. This, in turn, is putting upward pressure on services prices and wages.

“Indeed, services prices and wage inflation are the two main areas of concern when it comes to the disinflation path,” he wrote. “Unless goods inflation declines further, rising services prices and wages may keep overall inflation higher than desired.”

This situation alone, even without other factors such as excessive government spending and fracturing global trade crimping supply and pushing up goods prices, poses a “significant risk to the soft-landing scenario,” according to the IMF’s research director.

Excessive Spending, Deglobalization Risks

While the IMF doesn’t see any immediate market pressure on U.S. Treasury debt, it expressed longer-term concerns about the growth of U.S. debt and reliance on short-term financing.

“It is concerning that a country like the United States, at full employment, maintains a fiscal stance that pushes its debt-to-GDP ratio steadily higher, with risks to both the domestic and global economy,” Mr. Gourinchas wrote. “The increasing U.S. reliance on short-term funding is also worrisome.”