Deficit reduction critical says IMF's Lipsky

A top IMF official warned on Saturday that the United States must start down a budget deficit-cutting path relatively soon or face crushing debt service costs as interest rates rise.

Time's a-wasting, John Lipsky, first deputy managing director of the International Monetary Fund, said in an address at the annual American Economics Association conference here. It is critical to lay out the basis for credible medium-term fiscal adjustment, he said.

Lipsky praised recent steps by U.S. central bankers and politicians to support a weak economic recovery with expansionary monetary and fiscal policies. However, he said those steps make it less likely the United States can meet goals of cutting its deficit in half by 2013.

Both the monetary and fiscal stimulus measures have been controversial. The Federal Reserve in November provoked outrage with a $600 billion bond-buying plan that both domestic and international critics protested would weaken the dollar and lay the groundwork for a burst of inflation.

President Barack Obama and Congress agreed in December to a $858 billion tax package designed to support economic growth, but bond markets quailed over the its deepening of the $1.3 trillion budget deficit.

Although near-term fiscal consolidation measures could crimp economic growth and will be politically controversial, in the longer term they will fuel stronger growth, Lipsky said.

The risk is that if the United States cannot soon trim its deficit, doubts about the U.S. fiscal position could push longer-term interest rates higher, he said.

U.S. lawmakers worried about the deficit are pushing for spending cuts, but face opposition from others worried that tapping the fiscal brakes too soon could stall the fragile economic recovery.

Government debt crises that have most recently rocked Ireland, Spain and Portugal have raised concerns about the credit-worthiness of larger nations and have led many to wonder how long the United States can sustain high levels of deficit spending.

While Republicans in the United States have been the most outspoken in calling for spending cuts and rode a deficit-cutting rallying cry to big gains in November elections, they have so far backed away from pledges to slash spending.

Lipsky praised a proposal by a U.S. presidential commission to trim the deficit with a major tax code overhaul and deep spending cuts. Although the plan was controversial, it garnered more political support than expected.

However, the commission has still lacked sufficient backing to force congressional action, and there is little expectation that tax overhaul will take place this year.

(Reporting by Mark Felsenthal; Editing by Leslie Adler)