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Trump's Growth Plan to Overcome Fed Obstacles

Trump's Growth Plan to Overcome Fed Obstacles
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Friday, 31 January 2020 11:22 PM Current | Bio | Archive

The U.S. Bureau of Economic Analysis (BEA) just released the first estimate for GDP growth for the fourth quarter of last year. The 2.1% growth rate for the quarter means that the growth rate for the entire year of 2019 was 2.3%. That’s below what President Donald Trump promised.

Trump said that his policies would result in annual economic growth exceeding 3%, something not seen since 2005. He said that the combination of the elimination of counter-productive regulations and tax cuts for all Americans would be the policies that accelerated growth. What happened?

In 2017, through executive order, Trump was able to eliminate hundreds of regulations that proved to be a barrier to economic growth. He did that in the early months of 2017. By June, the beginning of the third quarter, Trump’s actions were providing positive results, as growth increased to more than 3%.

Growth remained in the 3% range for the next four quarters. Then at the end of 2018, growth slowed to just above 1%. Growth rebounded in the first quarter of 2019 but then slowed to just above 2% for the remainder of the year.

What happened? Was Trump wrong?

It turns out that Trump did not hit his targets mostly because of the Federal Reserve (Fed), which raised interest rates 8 times between Trump’s election victory and the end of 2018. Just as the economy was about to take off because of Trump’s policies, the Fed choked growth because it had an unfounded fear of inflation.

Making matters worse, the  Fed also reduced its balance sheet. That meant the Fed would sell hundreds of billions of dollars of bonds, which it had purchased as part of the quantitative easing policy instituted after the 2008-2009 recession. That action reduced the amount of money in circulation by nearly half a trillion dollars, which slowed economic growth.

In 2019, the Fed realized it had made a big mistake. Inflation was less than the target range of 2%, and there didn’t seem to be any inflationary pressure. So in July 2019, the Fed began to cut interest rates. It cut rates again in September and again in October. Usually it takes about six to nine months for the Fed’s policy actions to be felt by the economy. That’s good news for this year.

The Fed’s inflation fear comes essentially from three sources: increasing labor cost, excess demand in the economy, and price shocks from commodities — mostly in the energy sector. This year, and going forward, none of those factors will cause any increases in inflation, due mostly to Trump’s policies.

Wage increases will add to the cost of production only when those increases exceed productivity. In other words, if a worker is paid 3% more but does not produce more, costs will increase. But if wages rise by 3% and, at the same time, the worker produces 3% more, then labor cost will stay constant. Because Trump’s tax cut resulted in capital formation, productivity is running just slightly less than wage growth, so there is little wage inflation.

Excess demand will put increased upward pressure on prices, only if supply can not increase to meet the excess demand. Again, because Trump cut the corporate tax rate, business has much new capital to use to increase output to meet any increases in demand. That means excess demand will lead to higher growth, not more inflation.

Because Trump has set energy independence as a goal for the U.S., production of oil and natural gas has increased. Although not completely energy independent, the U.S. now produces sufficient amounts of energy that will be mostly shielded against geopolitical forces that may cause inflationary price spikes due to increased energy costs.

This means that although the consensus view is that economic growth will slow to 2% or less this year, the economy is really poised for increased growth going forward.  Fed policy is now in a growth-friendly position.

Trump has also won the trade war having signed new trade deals with Mexico, Canada, South Korea, Japan, and China. He is negotiating new growth-inducing deals with India and the European Union. The U.K. is next after Brexit. That will increase U.S. exports starting this year.

Corporations that were hesitant to increase investment in 2018 and 2019 now feel more confident. Consumer confidence is at or near record highs as incomes are rising and employment opportunities are increasing. This likely means more growth.

This year should see the best economic growth since 2005, likely exceeding 3%.

Dr. Michael Busler, Ph.D., is a public policy analyst and a professor of finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in finance and economics. He has written op-ed columns in major newspapers for more than 35 years.

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DrMichaelBuslerPhD
Just as the economy was about to take off because of Trump’s policies, the Fed choked growth because they had an unfounded fear of inflation.
fed, growth, economy, trump
798
2020-22-31
Friday, 31 January 2020 11:22 PM
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