A new President and a re-elected Republican Congress
In the sense of a policy establishment being upended, Donald Trump’s inauguration as President evokes memories of Ronald Reagan’s administration taking office. The breadth of issues on which the new President represents a breach with orthodox opinion is comprehensive: relations with Russia, China, and Taiwan; relations with EU; NATO; immigration control; the value of the dollar; and US Treasury debt management.
Trump as the non-ideological independent with an ideologically-conservative Republican Congress?
President Trump does not just embody a rupture with policy orthodoxy, he also represents a rupture with standard conservative economic analysis. The Republican Party in Congress, led by the Speaker Paul Ryan, has a programme focused on dealing with the principal challenges in the federal budget that are located in the so-called ‘mandatory’ demand-led spending programmes: Medicare, Medicaid, Social Security, and the debt interest that results from unrealistic budget planning. In many respects, the Republican Congressional agenda represents the unfinished policy agenda of the Reagan White House. It was domestic policy reforms to control spending to which the Reagan administration was unable to give effect.
The pragmatic, businessmen president with a taste for construction
President Trump is a conservative businessman with a pragmatic non-ideological approach to economic policy. He thinks that the government and country would be improved if they were run more like a business, and that there are deals that need to be struck in order to sort things out. The sense of cutting a deal is central to Trump’s new approach to trade. During his campaign, he made it plain that he did not want to touch entitlement programmes such as Social Security. Trump the businessman made use of debt in his companies, and he is not afraid to think about using public debt for infrastructure spending. Many politicians like building roads and railways, and new hospitals and school laboratories have an appeal, too. The more complicated matter of how those roads, hospital operating theatres, and laboratories are used gets less attention, however. Coming from the construction industry, it is not surprising that President Trump has displayed a keen interest in investing in America’s physical infrastructure. The US economy would benefit from a carefully-planned increase in public investment. As Cass Sunstein has made clear, however, choosing the right projects, and getting an acceptable rate of return on the investment, is a public-service challenge that tends to have a bias towards optimism.
The big question is how ambitious the President will be about his infrastructure agenda. Its success and consequences will depend on its speed and scale. Carefully-focused investment — and particularly if it supports locally-decided investment — may yield benefits. A large-scale badly-focused programme financed by debt could provide a strong pro-cyclical stimulus in the more mature phase of the US recovery from the Great Recession.
What is a realistic assessment of the economic capacity and growth potential of the economy?
The big questions, here, relate to how much spare capacity there is in the US economy, and what its realistic trend rate of growth might be. The Congressional Budget Office suggests the latter to be 2.1 per cent, and the Obama administration was a bit more optimistic, estimating it to be 2.3 per cent. President Trump is planning to raise economic growth to 4 per cent. Given the recent weakness in productivity, there should be a debate about how realistic that is. Some economists have thought that de-regulation could sustainably raise growth for a temporary period, before it falls back to seeming closer to 2.5 per cent.
An agenda of tax reform
The tax agenda that the President presented during his election campaign could provide fertile common ground for a programme of tax reform comparable to the 1986 legislation that widened the tax base and cut rates. Most of the recent emphasis has been on reforming the high rates of corporation tax, but there is huge scope to reform the federal income tax, and to address the Manhattan Skyline of marginal tax rates. The consequences of such a programme would depend on the detail. The plan set out in the election was scored as having the potential to add over $7 trillion to US public debt by the 2030s. Steven Mnuchin, however, told the Senate at his confirmation hearing as Treasury Secretary that the administration would want to ensure that it did not add to the deficit. This has already been dubbed the ‘Mnuchin rule’: that cuts in tax rates for higher-income groups have to be matched by reduction in deductions. The realism of the administration’s budget documents will be important. Mr Mnuchin suggested to the Senate that he was interested in the dynamic scoring of the revenue receipts arising from policy changes. This is an interesting suggestion, used cavalierly; however, it could aggravate the federal government’s fiscal challenge.
The US federal government has a huge long-term fiscal problem. At some stage, addressing it will involve making significant awkward decisions about taxation and public expenditure. It is not clear whether the expansive instincts of the new administration, or the ideological retrenchment of the Republican majority in Congress, will amplify or mitigate these long-term fiscal challenges.
And what about the Federal Reserve and monetary policy?
Monetary policy will be a big issue in the coming years. While Mr Mnuchin has maintained the Treasury Department’s established commitment to a strong dollar, the President has considered the merits of a more competitive exchange rate. At this stage of the economic cycle, the Federal Reserve Board would, in normal circumstances, be tightening domestic monetary conditions, even under the cautious leadership of Dr Janet Yellen. As well as the tightening that a central bank would normally be thinking about, the Federal Reserve also has to consider its hugely expanded balance sheet. This is the result of its unconventional measures, such as the quantitative easing (QE) pursued after 2008. For some years following the credit crunch and the Great Recession, there has been pressure — principally from the Republican Party — for greater Congressional oversight of the central bank, including an audit of the Federal Reserve Board’s monetary policies by the General Accountability Office. The President has criticised the conduct of monetary policy, and although his team have said that the new administration will respect the independence of the Federal Reserve, there may be more interest in modifying the legislation that governs the central bank than at any time since the early 1980s.
Parallels with the Nixon administration’s economic instincts?
In many respects, President Trump is the most statist and economically-interventionist Republican to enter the White House since Richard Nixon. In terms of international economic policy, there is an interesting parallel. In 1971, President Nixon broke the residual link between the dollar and gold, ended the Bretton Woods fixed-parity exchange-rate regime, and drove a coach and horses through the established international payments system. In his inauguration speech, Donald Trump showed that he was determined to pursue a mercantilist trade policy, which represents a challenge to the increasingly open international trading system that has developed over the last thirty years.
Like President Nixon, President Trump’s first approach to remedy an economic problem is to approach the corporation directly, or identify the sector involved. With Nixon, the culprits were the meat wholesalers and the steel corporations. President Trump has used Twitter to namecheck pharmaceutical firms, General Motors, and Lockheed. It would be fanciful to take the parallel further, but Nixon ended up presiding over an overheating economy and inflation. Given issues including the huge scale of the Federal Reserve’s balance sheet; the revival of business animal spirits; the interest in re-examining some of the regulation placed on banks after the credit crunch; the tax cutting, infrastructure, and other spending ambitions of the administration and the stage of the US economic cycle, it may be interesting to examine the information that yields on US Treasury Inflation Protected Securities (TIPS) to see what light they shed on future expectations about inflation.