Sign up to myFT Daily Digest to be the first to know about Peterson Institute for International Economics news.
As Donald Trump prepares for the White House, a theme is beginning to emerge: the era of fiscal restraint in the US could be coming to an end.
Mr Trump was scathing during the campaign about the increases in US national debt under Barack Obama, and the businessman at one point claimed implausibly that he would pay the entire $19tn stock off in eight years.
Yet as bond markets have been recognising over the past 48 hours, by prioritising tax cuts and an infrastructure package for the first 100 days of the Trump administration, his team appears to be envisaging a stimulus programme that comes at a time when the US is already close to full employment. That could mean not only higher growth, but quicker inflation.
If this is indeed what the Republican-led Congress signs up to next year, it would represent a major shift at a time when organisations including the International Monetary Fund have argued in favour of greater budgetary support around the world.
The upshot for the Federal Reserve could be an acceleration of the return to more normal interest rates.
“Fiscal policy is coming back big-time relative to what we have seen in the past five or six years,” said Torsten Sløk, chief international economist at Deutsche Bank. “From a Fed perspective if fiscal policy is coming back the corollary to that is monetary policy will have to do less easing.”
What does the plan entail?
Mr Trump’s plans for cutting personal and business taxes would, according to analysis from the Tax Policy Center, lead to a rise in the federal debt by $7.2tn over the first decade. In addition, Mr Trump’s transition team has pledged to invest $550bn in infrastructure and has spoken of ramping up defence spending, including adding 42 ships to the navy and renewing nuclear and missile defence. The agenda also includes supply-side measures such as a regulation-slashing blitz.
His sketchy fiscal plans will now have to be fleshed out in dialogue with Congress. A template on the tax side is the Better Way plan of Paul Ryan, House speaker, which is a more conservative package but overlaps with Mr Trump’s by reducing corporate income tax and consolidating the number of income tax brackets as well as lowering some rates.
How about the infrastructure side?
The fact that Mr Trump mentioned infrastructure in his acceptance speech in the small hours of Wednesday morning underlines how important this component is. He rode into victory on the back of support from Midwestern states where his supporters will want to see tangible signs of government action on jobs. New bridges and roads are an obvious way of delivering.
What will help Mr Trump in this area is the bipartisan consensus that has emerged over the need for renewal of US infrastructure. The American Society of Civil Engineers has projected a $1.44tn funding investment gap between 2016 and 2025 on infrastructure. Infrastructure was a component of Hillary Clinton’s plans for her first 100 days as well.
Trump advisers have suggested that he is willing to increase the national debt in order to provide federal funding for infrastructure, which would give a further push to the prospects of a fiscal stimulus. The problem is that planning infrastructure projects takes time, so it is not clear how quickly the growth effects would come.
What will Trump do on trade?
Mr Trump’s campaign promises to rip up or renegotiate deals like the North American Free Trade Agreement and combat unfair trade practices by China by imposing punitive tariffs have drawn dire warnings from economists of a potential return to recession.
Were he to pull the US out of Nafta, it would threaten the elaborate North American supply chains that many US corporations rely on. A trade war with China would yield higher prices for consumers and fuel inflation. It would also hurt companies that depend on Chinese imports as well as American farmers and other businesses for whom China has become an important export market. Delivered concurrently and in their most radical forms both pillars would yield a significant blow to US growth.
For that reason some trade experts have already begun to argue that, while a Trump administration is likely to bring more anti-dumping and other high-profile trade cases against China, it may not deliver the entire radical agenda he has threatened.
What about Fed reform?
Mr Trump’s advisers have suggested the Fed’s ultra-stimulative policies are unfair by penalising savers and have led to unequal implications for different segments of society. During the campaign Mr Trump was ferociously critical of Janet Yellen, the Fed chair, for her low-rates policies, but she is not expected to resign before her term expires in 2018.
The focus on the Fed will firstly be the filling of two vacant Fed Board seats, potentially with more hawkish policymakers. Secondly there is the question of reform proposals that have been circulating among Republicans in Congress for some time. These include measures to steer the Fed towards the use of stricter monetary rules — something it fiercely rejects. Mr Trump’s arrival could provide a boost to conservative lawmakers advocating those ideas.
What does this mean for the economy?
While Republicans have tended to brand themselves as the party of fiscal conservatism, their new president may lead them down the path of stimulus. And while the party used to fly the free-trade banner, Mr Trump ran on a platform of protectionism — which would alienate Republican business backers. Untangling the true policy priorities is going to be fraught.
“These are promises and not proposals,” said Diane Swonk of DS Economics. “The question is which promises does he deliver to core constituencies who got him elected, and what does he deliver on the pro-business side?”
Get alerts on Peterson Institute for International Economics when a new story is published