IMF warns U.S. debt default could damage global economy

The International Monetary Fund chief warned the U.S. on Thursday that failure to raise the debt ceiling could do deep damage to both the American and global economies.

Christine Lagarde, speaking at a news conference, told the U.S. to put its "fiscal house" in order, referring to the deadlock over passing spending and debt limit bills. Lagarde's comments began an annual meeting of global financial leaders by the IMF and World Bank.

"Obviously, we know, and you know by now, that failure to raise the debt ceiling would cause not only serious damage to the U.S. economy but also to the global economy as a result of the spillover effects," Lagarde said. "It is not helping the U.S. economy to have this uncertainty and this protracted way of dealing with fiscal issues and debt issues," she added.

She said the global economy is in a slow and unbalanced recovery and urged Europe to clean up its banking problems and forge ahead with a banking union.

U.S. shutdown dominatedIMF/World Bank meetings

But the U.S. political impasse dominated the discussion at the Washington meetings. It comes at a time when the IMF and other economic experts are counting on an improving U.S. economy to help carry the fragile global economic recovery.

These new concerns are layered on top of anxiety over an expected reduction in the central bank's bond-buying program to stimulate the economy. The prospect of that reduction has put significant pressure on markets in developing countries even before it has actually begun.

The mounting worries about the U.S. mark a shift for the Washington-based IMF. After years fretting about the deep economic crisis in Europe, the focus of most concern is now in the IMF's own backyard.

The U.S. government partially shut down last week after lawmakers in the House and Senate failed to agree on a spending bill to fund government at the start of the new fiscal year. Republicans in Congress are refusing to approve a temporary spending bill, demanding changes to or elimination of President Barack Obama's 2010 health care law. They are linking the health care plan to the budget battle because they contend the costs of it could severely harm the U.S. economy. Democrats say Republicans want to challenge legislation approved three years ago.

Separately, Democrats and Republicans are also clashing over the approaching deadline to boost the government's $16.7 trillion borrowing limit. Republicans are demanding spending cuts to reduce the budget deficit as the price for supporting an increase in the debt ceiling.

Obama and fellow Democrats insist that Congress first end the shutdown and extend the debt limit before any negotiations. They say spending and debt ceiling bills are vital and should not come with conditions attached.

If political infighting does real damage, such as forcing a debt default, experts fear it could imperil the entire global recovery.

Adding to uncertainty, the Federal Reserve is expected to begin scaling back its extraordinary stimulus early next year. The $85 billion a month in bond purchases have injected cash into the sluggish economy to boost growth.

The easing will be a sign that U.S. monetary policymakers believe the economy is strong enough to stand on its own.

But the IMF is warning that managing a smooth transition out of the stimulus could prove challenging as both interest rates and market volatility rise. If the withdrawal is too rapid, it risks unsettling markets.

Maintain stimulus, Lipton urges

IMF first deputy managing director David Lipton, speaking beside Lagarde at the same news conference, said he believes U.S. authorities need to maintain the stimulus, which is contributing to supporting both the U.S. and global economies.

"What's at issue is whether to have the foot a little less firmly on the gas pedal," he said.

At the same time, Europe is emerging from a deep recession and is expected to return to only very low rates of growth.

The IMF now sees the dynamics of global growth shifting, with the U.S. expected to drive expansion in the near term, helped by European and Japanese economies recovering from their slump.

Earlier this year, the IMF saw that developing economies such as China, India and Brazil would be the drivers of the global economy this year. Those emerging economies have been rocked since May by anticipation that the Fed will begin easing off its stimulus.