By Nick Mann | 5 June 2013

The managing director of the International Monetary Fund has warned the US that drastic spending cuts are damaging its economic recovery and a longer-term plan is needed to bring down its debt and deficit.

Speaking at an event in Washington DC yesterday, Christine Lagarde said the US had ‘come a long way in a short time’. In particular, she hailed progress in fixing the financial system, which was helping to increase private demand. As a result, the US economy is expected to grow by almost 2% this year, and improve further next year.

‘Despite this progress, the US is not doing as well as it should, largely because of self-inflicted fiscal wounds,’ she noted. ‘This year alone, fiscal adjustment will constitute an enormous 2.5% of gross domestic product.’

The $85bn automatic cuts which took effect in March as apart of the fiscal cliff – known as 'the sequester' – could cut 0.5% of GDP from growth this year unless they are reversed, Lagarde said.

‘It is also an extremely blunt instrument, imposing deep cuts in many vital programmes—including those that help the most vulnerable – while leaving untouched the key drivers of long-term spending,’ she added.

Lagarde called on the US government to introduce more ‘back-loaded’ measures, which would reduce the immediate impact of the cuts on growth.

This should be combined with a longer-term plan to bring down the deficit and debt, she said.

The US has made ‘steady progress’ in reducing its deficit since 2009, and its debt-to-GDP ratio is expected to start falling in 2015, but government debt remained a ‘major concern’, she added.

‘Spending on key health care programmes and social security is expected to increase by two percentage points of GDP over the next decade. Interest outlays are also projected to increase by the same amount over this period as rates gradually return to neutral levels,’ she explained.

‘These factors could widen the budget deficit and put the debt-GDP ratio back on a worryingly upward path—and all from a relatively high starting point.’

As a result, the US government should put in place a ‘credible medium-term roadmap’ to bring down the debt, Lagarde said. She called for a balanced plan comprised of savings in benefit programmes and tax increases.

‘The bottom line is clear: while fiscal adjustment might be too aggressive in the short term, it is certainly far too timid in the medium term,’ she added.