President Trump's short-termism
Recently, I wrote an article on short-termism that focused on the problems that might occur when policymakers focus too much on creating programs that will help them get re-elected and fail to pay attention to the longer-run results of the programs that may not be that beneficial to their constituents.
The United States, I believe, is facing the consequents of short-termism right now.
The Trump administration, along with the Republican controlled US Congress passed a tax-reform bill in December 2017, aimed at getting the US economy growing at a faster pace.
In early 2018 they also passed a two-year budget deal aimed at further stimulating the economy.
Right now, the short-run impacts of these policy moves are captured in the projections of future economic growth built by officials at the Federal Reserve System.
In 2018, Fed officials are now expecting the US economy to grow by 2.8 percent. In 2019, the economy is forecast to be growing at a 2.4 percent rate; in 2020, the expected rate of growth is 2.0 percent; and for the longer-run, Fed officials see the economy growing at a 1.8 percent rate.
This picture is not inconsistent with the projections of many other economists.
The economic policies of the Trump administration are expected to have a relatively immediate impact on the economy…and then dissipate.
And, what are the longer-term prospects for the economy?
Well, given this forecast and given that the unemployment rate in the US is now 3.8 percent, considered by many to be at a level consistent with full employment, Federal Reserve officials are still expecting the unemployment rate to average 3.6 percent in 2018, and falling to 3.5 percent in 2018 and 2019.
This is really great news, something emphasized by Fed Chairman Jerome Powell in his speech to the ECB Forum on Central Banking at Sintra, Portugal.
The question marks that are raised by this picture of the future relate to what such an environment means for the future of inflation.
Please note at this time that the Federal Reserve officials project their inflation target to rise by on 2.1 percent, every year through 2020 and to average 2.0 percent in the longer-run.
The Fed’s longer-run target for inflation is 2.0 percent, so Federal Reserve officials would have a very hard time justifying a rate of inflation that came in at any higher level than they have produced.
But, the question becomes, if economic growth is to continue, even at the lower rates, and the unemployment rate is expected to drop down to 3.5 percent, what does the Federal Reserve see itself doing in order to keep inflation down around a 2.0 percent rate?
Well, the only indication it gives it that the effective Federal Funds rate, its policy rate of interest, will average 2.4 percent in 2018, 3.1 percent in 2019, and 3.4 percent in 2020.
The Fed policy rate of interest must continue to rise.
Right now, the effective Federal Funds rate is roughly 1.90 percent, with the range of the policy rate set at 1.75 percent to 2.00 percent. To hit the Federal Reserve forecast of 2.4 percent, the Federal Reserve would need to average another 50 basis points higher to the rest of year, which is consistent with the Fed’s current forward guidance. This would bring the policy range up to 2.25 percent to 2.50 percent.
Now the Fed has the effective Federal Funds rate jumping to 3.1 percent in 2019. Right now, the Fed’s forward guidance for 2019 is only three more increases in the policy rate. This would bring the range for Federal Funds up to 3.00 percent to 3.25 percent. So, averaging 3.1 percent for the year seems to be a stretch.
The point is that the Federal Reserve seems to be expecting a need for a greater movement of its policy rate of interest in the future.
The need to get the effective Federal Funds rate up to 3.1 percent in 2019 implies that maybe the Fed believes that it will need to combat more inflationary pressures by the end of 2018 into 2019.
This pressure would come from the faster economic growth forecast for 2018 and the fact that the added federal debt resulting from the Trump fiscal stimulus program and the two-year budget bill will need to be financed. That is, the federal debt of the government will substantially increase.
This throws another uncertainty into the mix. The Federal Reserve, while all this other stuff is going on, is trying to reduce the size of its securities portfolio. How much the Fed will be able to achieve in terms of the reduction in its securities portfolio is anybody’s guess, given the need to financial all the other federal debt that must be financed during the next two years.
Here, the longer-term impacts of the politician’s “short-termism” are starting to come out.
If the Federal Reserve only…and, I emphasize the word “only”…has to increase the effective Federal Funds rate to 3.1 percent in 2019 and 3.4 percent in 2020 in order to keep inflation down around 2.0 percent, this will be a minor miracle.
However, there is a cost to this. Economic growth drops off to 2.4 percent in 2019 and 2.0 percent in 2020 and 1.8 percent thereafter.
My guess is that the Trump administration would fight fiercely against this outcome. President Trump could not go into the election of 2020 will an expectation that economic growth would only be 2.0 percent that year.
More “short-termism” could be expected!
This is all working within the framework of the future that the officials of the Federal Reserve see. But, it is not an unrealistic picture.
Of course, the United States economy could receive a shock and go into a new recession. After all, the current economic recovery will be nine years old at the end of June 2018. This is one of the longest economic recoveries in US history. But, then that is another story.