Big spender?

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Trump Starts Making Economic Sense

Narayana Kocherlakota is a Bloomberg View columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.
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Donald Trump has offered up a number of questionable ideas on how to manage the U.S. economy. Some of his latest proposals, though, might make a lot of sense.

About a month ago, I urged the presidential candidates to explain what policies and leadership they would like to see at the Federal Reserve. So I was glad to see Trump address Fed-related issues in an interview with Fortune magazine last week.

His key comments: “We have to rebuild the infrastructure of our country. We have to rebuild our military, which is being decimated by bad decisions. We have to do a lot of things. We have to reduce our debt, and the best thing we have going now is that interest rates are so low that lots of good things can be done that aren’t being done, amazingly.”

I read this as calling for two forms of fiscal stimulus. One is more spending, especially on the military and on infrastructure such as roads and bridges. The second is maintaining low taxes despite high levels of government debt (in other remarks, Trump has favored tax reduction). Both could have a beneficial effect on the U.S. and global economy, creating the demand for goods and services needed to get inflation and employment back up to healthier levels.

Much, however, would depend on the Federal Reserve’s response. If the Fed raised interest rates aggressively to keep inflation unchanged, then the removal of monetary stimulus could cancel out the effect of the added fiscal stimulus. If, by contrast, the Fed refrained from raising rates, the effect could be magnified: If households and businesses expected more inflation in the future, they would be more likely to spend on goods and services immediately.

Trump appears to support the second Fed response. This is essentially a coordinated action by the government and central bank to rescue what, in the Fortune interview, he called an “already reasonably crippled economy.” It’s a policy similar to what Prime Minister Shinzo Abe has attempted in Japan.

To better understand what Trump is proposing, we need to know a little more about his attitude toward inflation. For example, would he want the Fed to keep interest rates low even after inflation -- and people’s expectations of future inflation -- has surpassed the central bank’s 2 percent target? If not, then the coordination of monetary and fiscal policy is a welcome way to help the Fed achieve its objectives without resorting to novel policy measures like negative interest rates. If so, then he is advocating the kind of policies that led to the Great Inflation of the 1960s and 1970s.

Another question is whether Trump would be comfortable with the Fed pursuing an inflation target higher than 2 percent (such as the 4 percent target suggested by Professor Larry Ball of Johns Hopkins University). This has been advocated as a way to give the central bank more ammunition to fight future recessions (by generating higher nominal interest rates, it would provide more space to lower them before hitting zero). But it would also give the Fed more room to support fiscal stimulus of the kind suggested by Trump.

These are among the most important economic questions that will face the new president. It’s great that Trump, currently the leading contender for the Republican nomination, is starting to answer them. Would Hillary Clinton, the leading contender for the Democratic nomination, be as willing to pursue a policy of low taxation, high government spending and low interest rates to address the country’s economic ills? Someone should ask her.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Narayana Kocherlakota at nkocherlako1@bloomberg.net

To contact the editor responsible for this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net