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 early 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 euro zone crisis and the threat of a political impasse in Washington over the looming fiscal cliff posed the biggest risks to the world economy.
The Fund said, however, there were signs that financial stress and global economic conditions may be stabilizing due to recent steps by major central banks to cut interest rates to spur growth, although economic activity remains sluggish.
The combined U.S. government spending cuts and tax rises to be implemented under existing law at the start of 2013 are seen by many as threatening to tip the economy back into recession.
The IMF has estimated that the tax increases and spending cuts amount to $700 billion in 2013. Unless avoided, this could contract U.S. gross domestic product by around 4.5 percent.
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.
It also said a temporary U.S. fiscal cliff was a medium-term probability event, and said that even if the cuts were quickly unwound, damage to the economy would be substantial because businesses and consumers would be unsure about tax and spending policies.
The severity of the economic effects would partly depend on the duration of the cliff - here, staff sees a temporary cliff, before measures or extensions could be implemented, as a medium-probability event, the IMF said.
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 not reach a deal to avoid the cliff.
The IMF said the U.S. economy could fall back into recession if Congress fails to avert the package of tax hikes and