Thursday, December 8, 2016

First Pass at Trumponomics: From a Reckless Monetary Policy to a Reckless Fiscal Policy, UCLA Anderson Forecast, December 2016

First Pass at Trumponomics: From a Reckless Monetary to a Reckless Fiscal Policy
David Shulman
Senior Economist, Senior Economist UCLA Anderson Forecast
December 2016

Contrary to prior expectations, stocks soared and interest rates surged on the election of Donald Trump. (See Figures 1 and 2) It seems that both the stock and bond markets were pricing in the radical reversal in fiscal policy occasioned by his election while ignoring the negative impacts of his immigration and trade policies. Put bluntly the markets are now anticipating stronger real growth, at least for a while, higher inflation and higher interest rates. We believe that the markets have got it right with respect to direction.

Figure 1. S&P 500, Nov. 26, 2015 – Nov. 25, 2016, Daily Data

Source: Standard and Poor’s via

Figure 2. 10-Year U.S. Treasury Bond Yield, Nov. 26, 2015 – Nov. 25, 2016, Daily Data

Our first pass at Trumponomics, which still remains quite vague, makes the following policy assumptions:
·        $300 billion/year annual mostly higher end personal tax cuts effective in Q3.
·        $200 billion/year corporate tax cut effective in Q3 with $50 billion of revenues associated with the repatriation of foreign earnings that quarter.
·        $20 billion/year infrastructure program effective in Q4.
·        $20 billion in higher defense spending in 2018.
·        $20 billion/year Medicaid/ACA cuts effective in Q4.
·        Relaxed energy, environmental and financial regulation.
·        Modest changes to immigration except for border wall/fence.
·        Modest changes to trade policy yielding net reductions in food and aircraft exports phasing in starting mid-2017.

The net result is a massive fiscal stimulus on an economy at or very close to full employment and is directionally what a host of liberal economists have been advocating for the past five years. To be sure the mix tax cuts and spending is far different from what they desired, but make no mistake this is real or even reckless fiscal stimulus. How so? The federal deficit will roughly double to over one trillion dollars by 2018.  (See Figure 3) Simply put an economy operating at full employment should not have a deficit equal to 5% of GDP; the budget should be in balance or in surplus. Thus in the next recession the federal deficit will make the deficits associated with the financial crisis look small. In a way policy going policy will be the mirror image of the past five years as the reckless zero interest rate/QE policy gives way to its fiscal equivalent. Further Europe will follow the U.S. with more aggressive fiscal policies to meet the growing populist challenge.

Figure 3. Federal Deficit, FY2007 -FY2018F

Sources: Office of Management and Budget and UCLA Annual Forecast

In response to higher inflation and the exploding federal deficit the long quiescent Fed will become more aggressive with respect to monetary policy. This month’s expected increase in the federal funds rate will be followed up with many more pushing the rate up to above 2% by the end of 2017 and above 3% by the end of 2018. (See Figure 4) Remember President Trump has two vacancies to fill right away and Chair Yellen’s term expires in January 2018. Trust me; we will have a much different Fed under President Trump. Similarly the yield on 10-year U.S. Treasury Bonds is forecast to exceed 3% by the end of 2017 and 4% by the end of 2018. We know this sounds aggressive but it looks like we are in for, what economists call, a regime change.

Figure 4. Federal Funds vs. 10-Year U.S. Treasury Bonds, 2007Q1 -2018Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast

With $500 billion in tax cuts arriving in the third quarter of 2017 we expect economic growth to accelerate from the recent 2% growth path to 3% for about four quarters. Thereafter growth will slip back to 2%. (See Figure 5) Why so little? First it is hard to stimulate an economy operating at about full employment and second the higher interest rates we foresee will begin to bite. In order to maintain 3% growth or higher the economy will need a productivity miracle. Whether that will come from as the Trump partisans expect the supposed supply side effects of the tax cuts and the proposed regulatory reforms remains to be seen. We would also note that our forecast is likely higher than what Trump’s Democratic opposition would expect.

Figure 5. Real GDP Growth, 2007Q1 -2018Q4F, Percent Change, SAAR
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

In this environment employment will continue to grow with job growth on the order of 140,000 a month in calendar 2017 and 120,000 a month in calendar 2018. (See Figure 6) To be sure if the new administration follows through with its campaign rhetoric to engage in mass deportations then job growth and the economic activity associated with it would be far slower than what we forecast. The unemployment rate is forecast to fall to around 4.5% by the end of 2017 and remain there through 2018. (See Figure 7)  Further as the labor market tightens wage growth will accelerate to 4% or more from the middle of 2017 on. (See Figure 8)

Figure 6. Payroll Employment, 2007Q1 – 2018Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 7. Unemployment Rate 2007Q1 – 2018Q4F
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 8. Compensation/Hour, 2007Q1 -2018Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

With year over year core inflation already rising above 2%, it should no surprise to anyone that this rate will accelerate to at least a 2.5% pace; a forecast we view as conservative. (See Figure 9) As oil prices rebound headline inflation will approach 3%. Therefore if we are roughly right about the economy operating at full employment with an unemployment rate of 4.5%, inflation exceeding 2.5% and the prospect of a one trillion dollar annual federal deficit, it should surprise no one that interest rates would be heading much higher.

Figure 9. Consumer Price Index, Headline vs. Core Inflation, 2007Q1 -2018Q4,

The Good, the Bad and the Ugly

The Good

The economic growth we envision will be powered by rising consumption, equipment and defense spending. Real consumption spending is forecast to increase at 3% and 3.7% in 2017 and 2018, respectively compared to 2.6% this year. (See Figure 10) Consumption growth will dampened by an increase in the saving rate as high end consumers stash some of their tax savings and benefit as well from the rise in interest rates. (See Figure 11) The saving rate rises from 5.7% in 2016 to 7.6% in 2018.

Figure 10. Real Consumption Spending, 2007 -2018F, Percent Change, Annual Data
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 11. Saving Rate, 2007 – 2018F
Source: U.S. Department of Commerce and UCLA Anderson Forecast

Responding to lower corporate taxes and the likelihood of 100% expensing for tax purposes equipment spending is forecast to rebound from a 2.2% decline in 2016. Although we maybe on the conservative side here, we are forecasting increases of 4.5% and 6% in 2017 and 2018, respectively. (See Figure 12) Although the Trump plan includes 100% expensing for buildings along with the elimination of the business interest deduction, we are not sure this part of the plan will be enacted. This aspect of his plan raises a host of issues to geeky to discuss here.

See Figure 12. Real Equipment Spending, 2007 – 2018
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

We have been forecasting a turnaround in defense purchases over the past two years. With the election of President Trump it is upon us. After declining six years in a row real defense spending is forecast to increase by 0.8% and 3.2% in 2017 and 2018, respectively. (Figure 13) This is one spending priority that is expected to achieve broad support.

Figure 13. Real Defense Purchases, 2007 – 2018F, Percent Change, Annual Data
U.S. Department of Commerce and UCLA Anderson Forecast

The Bad

Housing activity will likely be a casualty of the economic environment we envision. The speed of the recent spike in long term interest rates and the prospect of further increases will dampen housing demand. Instead of the 1.4 million level of housing starts that we were previously looking for in 2017 and 2018, we are now looking for a far more modest level of starts in 1.2 million – 1.25 million range. (See Figure 14) To be sure this is an increase from this 2016’s estimated 1.17 million starts, but far below what we perceive to be underlying demographic demand of 1.5 million units per year.

Figure 14. Housing Starts, 2007Q1 -2018Q4F
Sources: U.S. Bureau of the Census and UCLA Anderson Forecast

The Ugly

Although President-elect Trump raged against imports and the trade deficit during the campaign, it looks like he will come up woefully short. Why? The consumer boom that his tax cuts will ignite will inevitably suck in imports. Further the change in policy mix from monetary policy to fiscal policy triggered a rally in the dollar making imports cheaper and exports more expensive. Recall where we started, we are not assuming a major trade war with our partners around the world.  If we are wrong here we are likely wrong everywhere. We are assuming that there will be minor tweaks to trade policy that would modestly reduce imports (mostly in the auto sector) and trigger modest retaliatory actions affecting aircraft and farm exports. As a result imports continue to rise and exports flat-line. (See Figure 15 and 16)

Figure 15. Real Imports, 2007 -2018F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 16. Real Exports, 2007 -2017F, Annual Data, Percent Change
Sources: U.S. Department of Commerce and UCLA Anderson Forecast 

The slowdown in trade that we envision is, unfortunately, only the beginning as the broad postwar consensus favoring open markets has broken down. The bi-partisan collapse of the Trans Pacific Partnership (TPP) and the Brexit vote signaled that we are moving to a more protectionist world and the age of ever increasing globalism is over, at least for now. The world will be a poorer place for it.

A Note on Infrastructure Spending

We do not believe that President-elect Trump’s tax credit based infrastructure plan will pass muster in Congress on the scale he is looking for.  Simply put he is proposing $137 billion in tax credits for private investors to fund major infrastructure projects. The problem is that in order for this to work it requires a revenue stream and there aren’t any revenue streams associated with highway, bridge and tunnel, wastewater and transit maintenance. Thus we anticipate a more traditional infrastructure program amounting to a more modest $20 billion dollars a year of direct taxpayer funding.  We could very well be low here, but it will take time for an expanded infrastructure program to ramp up.

Nowadays as President Obama discovered to his chagrin there are very few “shovel ready” infrastructure projects around awaiting funding. We live in a world of environmental impact studies and Davis-Bacon Act labor codes regarding prevailing wages. Thus if the President-elect wants quick action Congress would have to waive or fast-track the environmental requirements and waive provisions of the Davis-Bacon Act. This would be a tough sell for the Democrats, but the Republicans are in the majority.

A Note on the Deficit

Several my colleagues have cautioned me about the so-called “deficit hawks” in the Republican Party who would fight fiercely against the projected one trillion dollar deficit we are calling for in 2018. My response is that the Republicans want Trump to succeed and they won’t fight him. This is very similar to the evangelical wing of the Republican Party holding its nose and supporting Trump, whose life story certainly raised serious questions for that faction, in the general election against Hillary Clinton. Moreover the Trump Republican Party is not the party of Reagan; it is more a Jacksonian working class party that cares more about jobs than deficits.


The election of Donald Trump signaled a major regime change in economic policy. We are transitioning form a reckless monetary policy to a reckless fiscal policy. In the short run that will bring with it more real growth and inflation along with higher interest rates. However, because the economy is operating at or close to full employment, the growth spurt will be short-lived and we will return to the 2% growth economy of the past seven years. However we will be left with mega-deficits that will make it more difficult to fund the retirement and health programs that voters expect.  And the real risk is that a more aggressive Trump Administration trade policy would trigger a growth killing trade war. Thus we would caution that because there are so many ill-defined moving parts there is higher degree of uncertainty in this forecast compared to prior ones.

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