The macroeconomic implications of the US President-elect’s fiscal plans
Much will remain unknown about the policies to be pursued by the United States’ new president-elect, Donald Trump, until after he enters into office on 20th January 2017. However, he has promised substantial change in many areas, including fiscal, trade, and immigration policies, and his largely unexpected election victory has led to reactions in financial markets which reflect expectations that at least some policies will evolve broadly in the directions he has indicated. This is true particularly of fiscal policy, where expectations of more expansionary policy, including tax cuts and action to raise infrastructure investment, appear to have contributed to significant increases in longer-term interest rates and rises in equity prices in the United States and other advanced economies.²
The following analysis of the implications of an expansionary shift in US fiscal policy of the kind outlined in the president-elect’s proposals indicates that the results would include a short-term, but not sustained, boost to GDP growth, an appreciation of the US dollar, and a widening of both the fiscal and external current account deficits. The increased fiscal deficit implies a faster increase in government debt than expected under current policies. To keep the government debt-to-GDP ratio at the level prevailing at the beginning of 2017, offsetting measures would be needed. If these were to take the form of cuts in government consumption, the cuts would need to be significant - of the order of 10 per cent. These results are, of course, based on particular assumptions, including those embedded in our macroeconomic model and the assumption of no significant effects of the assumed policy measures on the supply side of the economy.
¹ The authors would like to thank Oriol Carreras, Jagjit Chadha, Ian Hurst, Simon Kirby, Rebecca Piggott and James Warren for helpful comments and suggestions.
² By early December, 10-year government bond yields in the US were close to 50 basis points higher than just before the election on November 8th, with stock market prices in the US about 5 per cent higher. Lloyd (2016) decomposes these post-election developments into changes in interest rate expectations and term premia.