Trump Counts on Fed to Help Sustain Economic Bump From Tax Plan

  • White House’s Hassett says package will boost productivity
  • Fed watchers caution it will lead to higher interest rates
Prestige Economics' Expects 4 Fed Rate Hikes in 2018

The Trump administration is banking on the Federal Reserve not to squelch any bump in economic growth from the Republican tax plan.

White House chief economist Kevin Hassett argues that the tax overhaul will boost productivity, allowing the U.S. economy to grow more rapidly without risking a damaging bout of higher inflation that would be an anathema to the Fed.

“I totally respect the independence of the Fed. I would never give them advice,” Hassett, who heads President Donald Trump’s Council of Economic Advisers, said in a Nov. 16 interview. But such supply-side boosts to the economy “don’t create interest-rate paths that are wildly inconsistent” with the Fed’s current projections, according to macroeconomic models.

U.S. central bankers have penciled in one more rate hike this year and three more in 2018, based on the median projection of policy maker forecasts released in September.

In making their predictions, most officials either did not assume a tax cut would take place or marked down their estimates of the impact of any fiscal action, according to the minutes of their Sept. 19-20 meeting.

If Congress passes tax cut legislation in the coming weeks, Fed policy makers may lift their rate projections for 2018 to four at their next meeting on Dec. 12-13, said Vincent Reinhart, chief economist at Standish Mellon Asset Management Co. and a former Fed official.

The centerpiece of the Republican tax plan is a reduction in the corporate rate to 20 percent from 35 percent. The House of Representatives last week passed its version -- which includes individual income-tax cuts as well -- while the Senate is still working on its bill.

Hassett acknowledged that the Fed would probably try to counteract the impact of a tax plan if the package was aimed solely at lifting demand -- a simple tax rebate would be an example of that -- or if inflation was way above the central bank’s target.

Neither is the case now, he maintained.

Productivity Boost

The planned reduction in business taxes will prompt companies to significantly increase productivity-enhancing capital investment in the U.S., Hassett said. While that spending will initially boost demand, its biggest impact ultimately will be on supply, enhancing the economy’s ability to grow without stoking inflation, he argued.

As measured by the personal consumption expenditure price index, inflation was 1.6 percent in September, below the Fed’s 2 percent objective.

Hassett said he expects the economy to rack up its third straight quarter of at least 3 percent growth in the final three months of this year and suggested that pace could be sustained into next year if Congress passes the tax package.

That would be well above 1.8 percent pace that Fed officials think is sustainable on a long-term basis, based on their median forecast in September.

Cautious Outlook

Monetary policy makers have reacted cautiously in recent days when asked how they’d respond if taxes were cut.

Cleveland Fed President Loretta Mester said the central bank needs “to wait and see what actually gets passed.”

She told reporters on Nov. 16 that she had already built a “small effect” from the tax plan into her forecasts for the economy. But the main reasons she thinks the Fed should continue raising rates is the “very strong” labor market and the likelihood that inflation will gradually rise.

Dallas Fed President Robert Kaplan said the U.S. government should be careful not to increase its debt as a share of the economy from levels that are already “historically high.”

While tax reform and deregulation may encourage companies to relocate jobs to the U.S., fiscal policy measures should be considered against the backdrop of a healthy labor market, he told the Fox Business Network on Nov. 17.

Investors may get a clearer read on how the Fed will respond when Trump’s nominee to be the central bank’s next chairman, Jerome Powell, testifies to the Senate Banking Committee on Nov. 28. Powell, now a Fed governor, will take over the top spot from Janet Yellen in February if he’s confirmed by the Senate.

Johns Hopkins University professor Jonathan Wright predicted that monetary policy makers will view the likely tax plan “mainly as a demand boost at a time of full employment.”

“That is going to give them some cause for concern,” said Wright, a former Fed economist. As a result, they will “have a tighter path of policy than otherwise.”

— With assistance by Christopher Condon, and Steve Matthews

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