Macro-Wars Pave Path for Trump as Axioms of Economics Crackby and
Consensus around primacy of monetary policy tool is weakening
Backers of fiscal spending, infrastructure are gaining ground
Donald Trump has an invitation from economists to try something new.
Even before the election, Democrats such as Lawrence Summers and Jason Furman helped put fiscal policy back in vogue. Central bank regimes are under review, and there’s a sharper focus on economic losers after decades of liberalization worsened income inequality.
Furman, current chairman of the White House Council of Economic Advisers, said the old view of fiscal policy as an ineffective tool is “shifting.” The reevaluation isn’t only happening in the U.S.: In Japan, Prime Minister Shinzo Abe’s government is pushing for a greater role for fiscal policy next year, according to draft guidelines for the 2017 budget seen by Bloomberg.
Financial crises, weak recoveries, flat wages and populist backlashes in western democracies have underscored doubts over economic beliefs held for a generation. The insurrection in economics opens a window for Trump to push policies that a few years ago would have seemed heretical to a profession wedded to free trade, open capital borders, fiscal restraint and the primacy of monetary policy.
“Practically everything related to monetary and fiscal policy will soon be on the table,” said Andrew Levin, a Dartmouth University professor and former adviser to Federal Reserve Chair Janet Yellen.
Monetary policy is on the back foot in the euro area, and in the U.K., the political convulsions of Brexit have made short work of economic forecasters’ best-laid plans. Meantime, China’s success in weathering tepid global demand with infrastructure investment and the Bank of Japan’s failure to convincingly reflate the economy by hoovering up ever more debt is adding to the field’s introspection.
“What I worry about is that the economics profession has shot itself in the foot,” said William White, chairman of the economic and development review committee at the Organization for Economic Cooperation and Development, in Paris. “People have claimed to have solutions that are simple and effective when in reality the solutions that they’ve brought forward might or might not work.”
Investors have already started pricing in a regime shift to higher inflation and more growth. Yields on U.S. 10-year notes stand at 2.34 percent versus 1.85 percent on Election Day on Nov. 8. The S&P 500 Index has climbed near a record high.
The details of Trump’s policies and how the Congress will shape them remain to be seen. His stated goals include deregulation, tax cuts, and infrastructure spending to grow the economy at 3.5 percent a year on average over a decade. He will also be able to appoint two Fed governors -- and, down the road, a chair when Yellen’s term at the helm ends in 2018.
On the flipside are threats of punitive tariffs on China, Mexico and other nations and limits on immigration. Conventional economics suggests both would be a brake on growth.
“The concerns I have are on the supply side,” said Scott Sumner, director of the program on monetary policy at George Mason University in Arlington, Virginia. “If he slows trade or slows immigration, then that hurts supply.”
Trump advisers such as Peter Navarro, University of California at Irvine professor, also argue for a tough approach to China. Such views spurred a rebuke from Stephen Roach, senior fellow at Yale University, who said on Bloomberg Television that Navarro should be "defrocked."
Cutting back on trade deals like the North American Free Trade Agreement or the prospective U.S.-E.U. equivalent TTIP, could throw a wrench into globally integrated production of everything from sweatshirts to cars.
And testing the scope of deficit finance in the U.S. and elsewhere could be destabilizing, with the Fed or Bank of England potentially seeing the need to offset fiscal priming by raising interest rates at a faster pace if inflation ensues.
Yellen told the congressional Joint Economic Committee Nov. 17 that if lawmakers decide to spend more, they should aim for investments that boost long-run growth and productivity, while keeping an eye on the deficit.
The cracks in the macroeconomic consensus became evident after the financial crisis of 2007-2009. Olivier Blanchard and the International Monetary Fund’s research department published a paper called “Rethinking Macroeconomic Policy” in 2010. Blanchard, an Massachusetts Institute of Technology-trained economist, and his co-authors said that too little attention was paid to the financial system, that inflation targets may have been too low, and that more research needed to be done to understand how fiscal policy could be a stabilization tool.
Then in 2013, Harvard professor Lawrence Summers began articulating his view of a new period of secular stagnation where excess saving and insufficient investment act as a brake on trend growth rates. The same year, Thomas Piketty’s book "Capital in the 21st Century" sharpened focus on unfettered capitalism’s tendency to worsen income inequality. Meanwhile, from the developing sphere former World Bank Chief Economist Justin Lin Yifu has championed China’s approach of spurring growth via supporting key industries and spending big on infrastructure.
The battle goes on. Paul Romer, now the chief economist of the World Bank, this year chastised his colleagues for their silo mentalities and the “mathiness” that he says a lot of research work hides behind.
Faced with lower rates of productivity and pessimistic views of potential growth, central bankers had only a couple of fallback solutions. Buy bonds, keep rates low, and hope the private sector and households invest and spend, even while trade regimes continued to clip away low-skill jobs. The U.S. election and Brexit show that voters want to try something new.
“Governments are being forced to rethink global growth beyond central banks. Muddling through is no longer enough,” said Lena Komileva, chief economist at G+ Economics in London. The narrow pool of winners from globalization “is unsustainable and the social backlash has marked the end of the economic liberalism of the past 20 years.”
In the U.S., Furman has argued the “new view” of fiscal policy was that it could help lift inflation and induce more investment by pushing the economy out of its slow-growth range. And even in Germany, the spiritual home of fiscal austerity in Europe, there are voices calling for a looser stance on spending. Marcel Fratzscher, head of the German Institute for Economic Research in Berlin, says Angela Merkel’s government should spend its 1 percent budget surplus on investments including infrastructure.
“Fiscal headroom is going to be the most important issue next year,” said Phillip Swagel, a University of Maryland professor and former U.S. Treasury assistant secretary. “We are going to have an experiment.”