United States Politics February 2017

United States

United States: Trump delivers on promises, fiscal stimulus plan on the horizon

January 30, 2017

Recently inaugurated President Donald Trump is making good on his campaign promises, increasing the odds that a fiscal stimulus plan is in the pipeline. An expansionary fiscal stance would provide an additional boost to the U.S. economy in upcoming years, primarily through sizeable tax cuts. Nonetheless, the existing risk of overheating a well-performing economy that is nearing full employment could see the Federal Reserve accelerating the pace of U.S. interest rate normalization to prevent an inflation overshoot. Be that as it may, the prospects of deregulation, tax reforms and public infrastructure projects have pushed the Dow Jones above the 20,000 mark for the first time ever in January and have buttressed business and consumer confidence. An important caveat, however, remains President Trump’s anti-trade policy, which threatens to erode the country’s domestic competitiveness and feed inflationary pressures through rising prices of imported goods.

Trump’s plans to boost growth to 4.0% and create 25 million new jobs are largely contingent on the success of his fiscal-easing plans, which are expected to be primarily supported by higher infrastructure and military outlays. However, Trump has yet to provide specific details on his much-heralded infrastructure package and priorities. Although he has already rolled out executive orders to expand the wall on the border with Mexico, with Congress set to earmark up to USD 25.0 billion for this, a fully-fledged blueprint is still in the making.

In this context, analysts have instead turned their attention to the proposed tax reform. Trump’s tax plan envisages a larger standard deduction, fewer tax brackets and lower rates for both individuals and businesses. As part of Trump’s commitment to bring back production facilities to the U.S., the fiscal blueprint could also include an import tax and levy exemptions for exports, which is part of the “border-adjustment tax” Republicans have long sought.

The Republicans control both the Congress and Presidency, and yet the path to implementing Trump’s fiscal reforms may not be entirely smooth. Although the Trump administration argues that tax reforms would support higher growth and thus a lower fiscal deficit, expansionary fiscal policies are likely to lead to a deterioration in public finances, which will either led to dramatic cuts in spending in other areas or a sizeable rise in the deficit. Given the contentious debate over the fiscal deficit in recent years, the fiscally conservative Congress is unlikely to greenlight Trump’s plans to their full extent, but instead to pass less ambitious programs, curtailing infrastructure spending in particular.

The Federal Reserve has also repeatedly pointed to the untimeliness of a fiscal stimulus plan. With employment nearing its full capacity, inflation gradually firming up and the prospect of higher import prices if Trump’s anti-trade policies come to fruition, there is a risk that consumer prices will rise beyond the 2.0% targeted by the Fed. This could prompt the Central Bank to act pre-emptively, accelerating the pace of its interest rate hiking cycle in a bid to tame inflationary pressures. This stance, however, would thwart the President’s objective of 4.0% economic growth, since higher interest rates would most likely led to tighter financial conditions. On how the Fed is likely to behave in upcoming months, Bern Weidensteiner and Dr. Christoph Balz, Economists at Commerzbank, comment:

“The Fed will (…) see little need to act for the time being, and certainly not at next week's meeting. It will probably prefer to wait and see exactly which plans Trump really intends to implement, and how much will be mere political wrangling with Congress. It may even want to see the first effects on the real economy; for example, by waiting to see how US businesses respond to tax cuts. Indeed, it is unclear whether corporate America will use the tax cuts to boost investment; whether they will run down debt or even buy back their own equities in order to raise share prices.”

Although Trump has started his term with a bang, a high degree of uncertainty persists. Even if his fiscal blueprint materializes, economic activity is not expected to benefit from it until 2018. Thereafter, as the boost from fiscal easing wanes and tougher immigration and monetary policies come into play, the outlook for the U.S. economy will deteriorate, dragged down by a mounting debt burden, dwindling household purchasing power and sizeable structural problems. One of the few silver linings amidst the gloom is to be found in the surge seen in Keynesian ‘animal spirits’, which could help business activity and investment to soar and lay the ground for stronger, more sustainable economic growth.

While the President’s administration targets growth of 4.0%, FocusEconomics analysts expect the boost that Trump can add to U.S. growth in upcoming years to be modest at best. They see GDP growth 2.3% in 2017—up 0.1 percentage points from last month’s estimate—and 2.4% in 2018.

Author:, Economist

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