Could US fiscal expansionism lead us to QE4?

The credit crunch era has been one where monetary policy has taken centre stage. There are many ways of expressing this but one is that technocrats ( central bankers) have mostly run the economic show as elected politicians have chosen to retreat to the sidelines as much as possible. Whatever you may think of President Trump he is not someone who is happy to be on the sidelines as he has exhibited publicly once or twice with some pushing and shoving. But more importantly we are seeing something of a shift in the balance of US economic policy as the monetary weapon gets put away at least to some extent but the fiscal one seems to be undergoing a revival.

A relatively small reflection of this was last night’s budget deal. We have become used to talk of a US government shutdown followed by an eleventh hour deal and no doubt there is a fair bit of both ennui and cynicism about the process. But as the Washington Post notes as we as giving the national debt can another kick there was this in the detail.

According to outlines of the budget plan circulated by congressional aides, existing spending caps would be raised by a combined $296 billion through 2019. The agreement includes an additional $160 billion in uncapped funding for overseas military and State Department operations, and about $90 billion more would be spent on disaster aid for victims of recent hurricanes and wildfires.

An increase in military spending was a Trump campaign promise so it is no surprise but spending increases come on top of the tax cuts we saw at the end of last year.

The Trump Tax Changes

According to the US Committee for a Responsible Fiscal Budget there was much to consider.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years, leading debt to rise to between 95 percent and 98 percent of Gross Domestic Product (GDP) by 2027 (compared to 91 percent under current law). However, the bill also includes a number of expirations and long-delayed tax hikes meant to reduce the official cost of the bill. These expirations and delays hide $570 billion to $725 billion of potential further costs, which could ultimately increase the cost of the bill to $2.0 trillion to$2.2 trillion (before interest) on a conventional basis or roughly $1.5 trillion to $1.7 trillion on a dynamic basis over a decade. As a result, debt would rise to between 98 percent and 100 percent of GDP by 2027.

This is a familiar political tactic the world over where the numbers depend on others taking the difficult decisions in the future! One rather sneaky move is the replacement in terms of income tax thresholds of inflation indexation by the US Consumer Price Index by the chained version which is usually lower. So jam today but more like dry toast tomorrow.

Won’t this boost the economy?

There are enough problems simply doing the direct mathematics of government spending and revenue but the next factor is how do they effect the economy? Well the US Congress has given it a go.

The Joint Committee staff estimates that this proposal would increase the average level of output (as measured by Gross Domestic Product (“GDP”) by about 0.7 percent relative to average level of output in the present law baseline over the 10-year budget window. That
increase in output would increase revenues, relative to the conventional estimate of a loss of $1,456 billion over that period by about $451 billion. This budget effect would be partially offset by an increase in interest payments on the Federal debt of about $66 billion over the budget
period.

The idea of tax cuts boosting the economy is a reasonable one but the idea you can measure it to around US $451 billion is pure fantasy. To be fair they say “about” but it should really be if you will forgive the capitals and emphasis “ABOUT“. Anyway for the moment let us move on noting that there is already a fair bit of doubt about the impact on the US deficit over time from US $1 trillion or so to a bit over US $2 trillion.

What is the deficit doing?

According to the US CBO ( Congressional Budget Office) it has been rising anyway in the Trump era.

The federal budget deficit was $174 billion for the first four months of fiscal year 2018, the Congressional
Budget Office estimates, $16 billion more than the shortfall recorded during the same period last year.
Revenues and outlays were higher, by 4 percent and 5 percent, respectively, than during the first four
months of fiscal year 2017.

As you can see revenues are doing pretty well and in fact are being led by taxes on income being up by 8%. However spending rose even faster at an annual rate of 5% which at a time of economic growth gives us food for thought. There was one curious detail and one familiar one in this.

Social Security benefits rose by $11 billion (or 4 percent) because of increases both in the number of beneficiaries and in the average benefit payment.

That seems odd at a time of economic growth but the next bit reminds us that the rise in inflation has a cost too due to index-linked bonds called TIPS.

Outlays for net interest on the public debt increased by $13 billion (or 14 percent), largely because of differences in the rate of inflation.

More Spending?

It looks as though we will find out more about the much promised infrastructure plan next week. From Bloomberg.

President Donald Trump expects to release on Monday his long-awaited plan to generate at least $1.5 trillion to upgrade U.S. roads, bridges, airports and other public works, according to a White House official.

How much of this will come from the government is open to debate. The modern methodology is to promise some spending ( in this case US $200 billion) and assume that the private-sector will do the rest. One of the more extraordinary efforts on this front was the Juncker Plan in the Euro era which assumed a multiplier of up to twenty times. But returning stateside we can see that there will be upwards pressure on spending but so far we are not sure how much.

Comment

In my opening I suggested that the United States was switching from monetary expansionism to fiscal expansionism. Let me now introduce the elephant in this particular room.  From the Atlanta Fed

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2018 is 4.0 percent on February 6, down from 5.4 percent on February 1.

They may well be somewhat excitable but if we look at the 3.2% predicted by the New York Fed the view is for pretty solid economic growth. So the fiscal position should be good especially if we add in the fact that for all the media hype treasury bond yields are historically still rather low. Yet none the less the fiscal pump is being primed. Or to put it more strictly after a period of pro-cyclical monetary policy we now seem set for pro-cyclical fiscal policy.

There are obvious implications for the bond market here as there will be increases in supply on their way. No doubt for example this has been a factor in pushing the thirty-year bond yield above 3%. You might have expected more of an impact but I am increasingly wondering about something I suggested some time ago that the path to higher interest-rates in the United States might be accompanied by QE4 or a return to bond buying by the US Federal Reserve. Should the economy slow at any point which would boost the deficit on its own then we could see it. Also this could be a factor in the weaker US Dollar as in is it falling to reflect the risks of a possible return to Quantitative Easing?

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?

Me on Core Finance TV