The voices of Tax Policy Center's researchers and staff
President Trump, who sees himself as the toughest guy in the room, is, along with his GOP allies in Congress, disarming the federal government’s ability to respond to a future economic slowdown.
In a seemingly frantic effort to boost the short-term economy, the president has pushed a tax cut that will add more than $1 trillion to the debt over the next 10 years (actually less than he would have liked), watched Congress increase federal spending by more than $300 billion over just the next two years, and has now proposed to pump another $200 billion in federal money into new roads and bridges and other infrastructure. The result: Even by his accounting, the nation is looking at a 2019 budget deficit of nearly $1 trillion, or 4.7 percent of Gross Domestic Product.
Pushing a big economic stimulus at a time when the economy is running at close to full employment and inflation appears to be rising is risky enough. But in the current environment, it creates another, less obvious, danger. The problem is that while US interest rates have bumped up a bit since last September, they remain very low by historical standards.
The result is that should the economy unexpectedly go south—perhaps due to a 2008-like financial crisis or some unforeseen geopolitical event—the US will be left with few weapons to respond. Low interest rates mean the Federal Reserve has little ability to respond in its usual way—by lowering short-term rates.
And with projected budget deficits rising from 3.5 percent of GDP in 2017 to 4.7 percent and the ratio of public debt to GDP due to top 80 percent in 2019 (by the White House reckoning), Congress will have few fiscal policy levers to pull.
But a more realistic story is worse than that. The Administration only gets the 2019 deficit to 4.7 percent of GDP by assuming well over $100 billion in spending reductions. But they are more than a little hard to imagine given that a bipartisan majority in Congress just increased spending by more than $300 billion.
Then, of course, there is the White House’s rosy economic growth assumption: 3 percent real growth or more each year through 2024 and the unemployment rate falling below 4 percent and staying there through 2021. That’s far more optimistic than TPC and other analysts think. If the economy does soften, those projections are out the window and the budget deficit will explode, even without a new stimulus.
For some context, in Fiscal Year 2007, just before the Great Recession, the federal deficit was 2.4 percent of GDP, about half what Trump projects for next year. By FY 2009, it had ballooned to 10.8 percent as a result of declines in tax revenue, automatic increases in spending for programs such as food stamps and Medicaid, and enacted stimulus. Government debt in 2007 was about 35 percent of GDP. By 2009, it increased to 52 percent.
“We are all Keynesians now.”
And, of course, congressional Republicans were horrified that first President George W. Bush and then President Obama aggressively increased spending in response to the financial shock, though both had much more fiscal flexibility than Trump will have.
For its part, the Fed is trying to give itself more room to maneuver by gradually raising rates and selling off some the massive amount of debt securities it bought during the financial crisis. But in the absence of inflationary pressures—and with the stock market suddenly skittish--the Fed is likely to move cautiously for at least the rest of this year and perhaps into 2019.
While there is a fiscal benefit to low rates—the government can borrow cheaply—there is a big downside: If the economy falters in the next couple of years, there will be little government can do about it.
Perhaps I shouldn’t be so worried about a slowdown. After all, the economy seems to be moving along relatively well. But that’s the thing about recessions. Like unpleasant relatives, they don’t always tell you they are coming.
Echoing President Nixon in 1971, President Trump and a majority in Congress may be having their own "We are all Keynesians now," moment. But they are doing so at an especially inauspicious time.
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