Vol 13 (2016) - Issue 6

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A Shift Away from Monetary to Fiscal Policy

Many uncertainties remain regarding the new Trump Administration and its economic plan. Uncertainty brings volatility in markets, exemplified by the sharp swings registered the day following the election results. If persistent, uncertainty is a downside risk to growth, through softer consumer spending and softer investment spending.
What appears clear from the campaign rhetoric is the shift towards pro-growth fiscal policy, notably tax cuts, infrastructure and defence spending and a pro-business energy policy. These fiscal measures are estimated to increase the deficit by USD 4.5-6 trillion over 10 years, a package markets have started to price in, as:
– Equities rally on stronger growth prospects,
– Long-term yields rise on higher deficit expectations,
– The USD strengthens on positive growth and interest rate differentials, and on expectations of a more aggressive Fed.

For the moment, we take a more cautious approach to the outlook than the markets: The economy will likely benefit in the first 12 months of the presidency from a small short-term boost that will subsequently be offset by emerging weak business confidence, weak investment spending and higher interest rates.
We herewith review the main features of the Trump campaign fiscal and trade policy proposals, the likely scenario and impact on the economy and the monetary policy reaction function.

1. Fiscal policy proposals:
– Tax cuts reduce revenues by USD  4-5.5 trillion over 10 years:
• Individuals: lower marginal tax rates (12%, 25% and 33%), with the largest tax cut benefiting high-income households (from 39.5% to 33%), capital gains and dividends (0, 15 and 20%), and the elimination of the Alternative Minimum Taxes and estate taxes;
• Corporations: lower tax rates from 35% to 15%, one-time repatriation holiday tax at a 10% rate, and faster depreciation schedules.

– Spending: Debt-financed infrastructure and defence spending (USD 500 billion). The energy
policy largely entails rolling back the regulatory framework set by the Obama Administration.

2. Trade policy proposals:
– Effective import tariff rates set at 40% on China; US goods imports from China total close to USD 500 billion a year (22% of total imports) and US goods exports to China total close to USD 117 billion a year (close to 8% of total exports) – Effective import tariff rates set at 35% on Mexico
– Withdrawal from TPP negotiations
– Withdrawal from NAFTA
– Labelling China a currency manipulator

3. The likely scenario:
– Tax cuts (both individual and corporate taxes) should be enacted early in the Trump presidency, as the Trump Administration and Congress broadly agree on such initiatives.
– The infrastructure and defence spending measures will, in our opinion, be much smaller than suggested and tougher to enact, as the House of Representatives remains under fiscally-conservative Republican control.
– The energy policy geared at promoting domestic production is a near-term positive for growth (and a negative for oil prices), with increased output of oil and gas. Longer-term, much will depend on the new Administration climate change commitments.
– Similar to the enactment of infrastructure spending, Congress will likely stand against the most extreme protectionist measures advanced by the Trump campaign, given its more free-trade bias.