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Wednesday, November 9, 2016

The Macro Implications Of The Trump Presidency

My feeling is that the rise in bond yields this morning is the correct reaction. The complete triumph of the Republican Party, and the utter failure of the Clinton Democrats, points towards a "dash for growth" strategy (or another "Morning in America"), mainly driven by tax cuts. Such policies are about the only possibility that could break the back of the secular bond bull market. I will note that this is probably the opposite of what Republicans say that they want, and so it is hardly a predetermined outcome.

The Political Calculus Of Near-Term Republican Dominance

With control of all of the elected branches of the Federal Government, the Republicans will not be in a position to blame economic failures on President Obama (although they will certainly try). At the level of microeconomics, I imagine that there will be efforts to enact various wish lists: slashing regulation, targeting programmes favoured by Democrats, etc. Whether the Republicans can take on the entrenched insurance lobby and repeal "Obamacare" (or "Romneycare") is an open question. One could imagine the Republicans moving to turn Social Security into a tax-sheltered investment pool, but one may note that Hillary Clinton's financial backers were pushing for the exact same thing. Although such policy changes matter for American citizens, I am only interested in commenting on business cycle issues.

The self-destruction of the Clinton campaign points to future political risk for the Republicans. Previously, the Clinton apparatus controlled the Democratic Party, and Bill Clinton was probably one of the best Republican Presidents of the postwar era (based on modern Republican views; Eisenhower was one of the best Keynesian presidents over that period).  The entire Clinton wing of the Democratic Party is probably implicated in the email scandal, and they are highly vulnerable to leaks from future investigations. The only real chance for the Democratic Party is to run an economic populist who is not tarred by the various scandals (following the footsteps of Bernie Sanders). (To be clear, the Democratic Party could easily cough up another weak candidate like Hillary, but the Republicans cannot rely on such complacency.)

As a result, Trump would not want to let the economy remain on its current pathetic growth path that leaves large parts of the electorate under-employed, as that would make him an easy target for such a populist. Therefore, a "dash for growth" looks like the best bet, but it will certainly be biased towards tax cuts and "tax expenditures" (achieving the same objective as spending by creating targeted tax credits). It seems likely that the Republicans will rely on "trickle down" economics, but we could also see some "infrastructure Keynesianism" (possibly packaged as "public-private partnerships"). As in the 1960s and 1970s, such non-targeted fiscal stimulus would probably raise inflation before it reduces underemployment.

The obvious objection to my scenario is that the Republican Party contains a great number of balanced budget advocates. My view is that the Republicans are greatly in favour of balanced budget amendments when the President is a Democrat, not so much during Republican administrations. As long as the moves are packaged as way of shrinking government, "sound finance" can be put on the back burner (particularly if Social Security is "reformed").

(c) Brian Romanchuk 2016


  1. This depends on inflation, right? I'm not sure I understand why we should expect inflation because of a tax cut (especially if biased toward the rich). If the supply side of the equation can satisfy increased demand (which seems likely), then it still seems like there will be little pressure.

    1. Yes, it depends on the circumstances. Although there is excess capacity in some areas, in others, markets are tight. An increase in demand (if not targeted at areas of excess capacity) might just drive up prices in the areas with no excess capacity.

      A tax cut is essentially untargeted, and so people might use the extra cash to buy more of the stuff that they are already buying. In other words, probably the areas with less excess capacity. (A tax cut aimed solely at the rich might cause little added spending; that is, it might be almost entirely saved. This would have no effect on inflation, but it also has no effect on growth or employment. It would largely just result in a larger government deficit, matched by higher private sector holding of government debt.)

      My analysis here is fairly intuitive; Hyman Minsky had a more formal model describing the situation in the 1960s. (I referred to it in earlier articles.) However, even without a formal model, I think one can troll through sectoral price and wage data, and see this effect. It also shows up in the various measures of underemployment.

      The difference from my admittedly loose arguments and more standard mainstream logic is that there is a tendency to refer to "the" output gap, which is supposed to measure the inflationary pressures in the whole economy. That concept will miss the problems caused by having different sectors (or regions) with different capacity utilisation.

    2. A tax cut for the rich would probably only feed asset prices.


  2. Where are resources tight? Seems to me the only real tightness is in labor for low wage jobs.

    1. I have not tracked down the data, but I have seen charts of the average wage of supervisory employees. It is growing at a faster pace than for non-supervisory employees. That is, there are a lot of workers looking for jobs, but the supply of experienced bosses is tighter. I looked at the unemployment rate by educational status awhile back, and the unemployment rate for college graduates (particularly with postgrad degrees) is close to the norms of recent decades, while those with less education are in worse shape. I discussed this in "The Case Against Growth and Stimulus."

      (Re-reading that article, I have flip-flopped my view on the odds of an infrastructure plan. At the time, Clinton was leading heavily in the polls, and I was not spending time thinking about a Trump victory. At the same time, I am still unsure whether Trump could get a lot of infrastructure spending done; I think stimulus would rely on tax cuts.)

      I think there are also regional disparities; rural areas are in a lot worse shape than some of the big cities. (I am less familiar with the regional data, but it fits the anecdotes that I pick up.)

      As a Canadian, I do not have any on-the-ground feeling for what is happening in the US; our housing bubble has not popped (yet), and so the construction trades in my part of country are in much better shape.

    2. I have a hard time seeing how a tax cut is going to generate demand for more bosses. Also have a hard time seeing how that would translate to general inflation.

      To me, it appears that "we" have gotten so good at making "stuff," that most any reasonable increase in demand can be satisfied without inflation provided we have raw materials (there are limits in real resources, but can't see that a tax cut would have that kind of impact). I *think* places where there is inflation is where people spend on labor: healthcare, education. There are rents to be considered in some markets as well. I can't quite see a Trump presidency translating into more demand for healthcare or education, though I suppose a tax cut for the rich could fuel NYC penthouse prices.

      I've been wrong before :)

    3. Once again, a tax cut that is saved has no effect on the economy. It only matters for inflation and growth if it increases aggregate demand.

      Unless the tax cut is somehow targeted at a particular sector, we cannot distinguish the effect of a change in aggregate demand due to a tax cut from the effect of an increase in transfer payments, or an increase in the wage bill for government workers.

      Simple (silly) example. Increased demand causes someone to set up a new Starbucks. There might be a lot of people they can hire to be baristas, but there are less people with a track record of managing baristas. The wages of the managers goes up, and that is part of the cost structure for the store. It raises prices, and hence the price level.

      Somewhat more seriously, the efficiency argument does not really work for a lot of services. The workers at a fast food store can produce food extremely efficiently on a dollar-per-calorie basis than the workers at a snooty restaurant, but the prices at the snooty restaurant will go up if the upper classes have more disposable income and eat out more.

      More generally, you can always see a big split between services and goods inflation in recent decades, although education, rent, and medical is a big part of that. However, we cannot strip out all of the sectors with rising prices and say that inflation is under control.

      I read various gold bug web sites for entertainment. People there have a lot of anecdotes about how particular prices are rising, and the gummint is making up the inflation data.


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