US Economics Analyst. 12 November 2016

Transcription

1 12 November 2016 Economic Implications of the Trump Agenda n n n n n President-elect Trump s proposals, if enacted, would have significant implications for the US economic outlook over the next few years, some positive and some negative. The positive fiscal impulse from his tax reform and infrastructure proposals could provide a near-term boost to growth and, depending on the specifics, could have positive longer-run supply side effects. However, other proposals could lead to new restrictions on foreign trade and immigration, which could have negative implications for growth, particularly over the longer term. President-elect Trump must also make several Fed appointments over the next year, which raises the possibility of somewhat tighter monetary policy than under current Fed leadership. We expect scaled-down versions of the tax reform and infrastructure policies to be enacted. We do not anticipate significant changes on immigration policy, but incremental restrictions seem likely. Mr. Trump s monetary policy views are still unclear, but slightly more hawkish appointments appear likely at this stage. Trade policy is the greatest unknown, but we expect that Mr. Trump would follow through on at least some of the trade policies he has outlined. We use the Fed staff s FRB/US model to simulate the potential economic implications of these four aspects of his agenda. We also analyze scenarios involving just the growth-positive items (mainly fiscal), the growth-negative aspects of his agenda (trade, immigration, and Fed policy), the combined effect of Mr. Trump s proposals, and our own assumed policy outcomes. Keeping in mind that our simulations are subject to considerable uncertainty, we draw three main conclusions. First, Mr. Trump s policies could boost growth in 2017 and 2018, but are likely to weigh on growth thereafter if trade and immigration restrictions are enacted, or if Fed policy turns more restrictive. Second, core inflation and the funds rate are likely to be higher for the next few years in almost all scenarios. Third, the risks around our base case appear asymmetric: a larger fiscal package could boost growth moderately more in the near term, but a more adverse policy mix would likely lead to a significant slowdown, higher inflation and tighter policy in subsequent years. Jan Hatzius (212) jan.hatzius@gs.com Goldman, Sachs & Co. Zach Pandl (212) zach.pandl@gs.com Goldman, Sachs & Co. Alec Phillips (202) alec.phillips@gs.com Goldman, Sachs & Co. Jari Stehn +44(20) jari.stehn@gs.com Goldman Sachs International David Mericle (212) david.mericle@gs.com Goldman, Sachs & Co. Elad Pashtan (212) elad.pashtan@gs.com Goldman, Sachs & Co. Daan Struyven (212) daan.struyven@gs.com Goldman, Sachs & Co. Karen Reichgott (212) karen.reichgott@gs.com Goldman, Sachs & Co. Avisha Thakkar (917) avisha.thakkar@gs.com Goldman, Sachs & Co. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to

2 President-elect Donald Trump s proposals could have both positive and negative effects on growth. The fiscal impulse from his tax reform and infrastructure proposals could provide a near-term boost to growth and, depending on the specifics, could have positive longer-run supply-side effects. However, other proposals could lead to new restrictions on foreign trade and immigration, which could have negative implications for growth, particularly over the longer term. President-elect Trump must also make several Fed appointments over the next year, which raises the possibility of somewhat tighter monetary policy than under current Fed leadership. Our assumption is that aspects of Mr. Trump s positions in each of these areas will take effect, but that the eventual policy outcomes will differ from the campaign proposals. To illustrate this, we use the Fed staff s FRB/US model to analyze the economic effects under four scenarios: (1) the growth-positive policies that Mr. Trump proposed in his campaign, (2) the growth-negative polices that he proposed in his campaign, (3) the combined effect of these scenarios, and (4) our own central assumption for policy outcomes over the next two years. There are other relevant aspects of the Trump agenda that are more difficult to gauge. For example, it seems clear that the Trump Administration and congressional Republicans are intent on repealing much of the Affordable Care Act, but it is not clear what this would be replaced with. This seems likely to present downside risks in the near term, if federal subsidies decline, weighing on health spending. We also omit Mr. Trump s focus on lightening the regulatory burden on certain industries, which would likely be positive for growth, but once again depends on specifics that are difficult to estimate. Finally, in this exercise we do not address the policy uncertainty that the election result has created. While some of the uncertainty involves policies that could ultimately have positive growth effects, like tax reform, it could nevertheless serve as short-term damper on activity. Fiscal Policy: A Big Boost Mr. Trump s three most important fiscal proposals are his tax reform plan, an infrastructure program, and his plan to boost defense spending. Mr. Trump s tax reform plan would reduce the top marginal rate from 39.6% to 33%, and the corporate rate from 35% to 15%. While there is no official estimate of the tax revenue reduction associated with his proposal, estimates by the Tax Foundation suggest an average revenue reduction of 2.1% of GDP over the next ten years, or just over $400bn in 2017, with a roughly $250bn reduction in individual income taxes and another $160bn reduction in corporate income taxes. 1. His infrastructure proposal might also run through the tax side of the ledger. Two of Mr. Trump s advisors recently published a plan that would seek to incentivize the private sector to increase investment in infrastructure projects that would be 1. Details and Analysis of the Donald Trump Tax Reform Plan, Alan Cole, September November 2016 Page 2

3 supported by future fees, such as tolls. 2. They suggest that 17% of the initial investment could be financed with equity and the remainder with debt. The government would then provide a tax credit equal to 82% of the equity to reduce the cost of financing, or $14bn in tax credits for every $100bn in investment. The most important question regarding this plan is how much of the infrastructure investment would be incremental, and how much would simply replace existing municipal debt-financed investment. For ease of analysis, we consider the tax credit as a corporate tax cut, and assume the plan is successful in generating as much new investment as its authors suggest, though this could overstate the plan s effects. We also note that while most of the focus has been on the tax credit-based plan, new material on Mr. Trump s transition website on infrastructure refers only to a $550 billion investment, with no other details. Mr. Trump also proposes to eliminate the defense spending cuts under sequestration, which would increase defense spending by about $40bn per year. However, he also proposes to reduce domestic spending in other areas, which would offset the defense spending boost and would result in little net change in federal spending. We use the Fed staff s FRB/US model to simulate the economic implications of these fiscal policy proposals. We start by computing a pre election baseline simulation of the economic outlook that is centred on the FOMC s September Summary of Economic Projections (black line in Exhibit 1). 3. Growth is around 2%, the labor market is close to full employment, core PCE inflation firms gradually towards 2% and the federal funds rate rises broadly in line with the FOMC s September dots. We then simulate each component of the fiscal proposals individually. 4. First, private infrastructure investment rises slowly in response to the investment incentives, as investment projects take time to implement (dark blue line). Real GDP growth is initially broadly unchanged but the infrastructure spending boosts growth persistently by about 0.1pp from mid Second, the personal income tax cut provides a large and immediate boost to growth. Annualized real GDP growth is lifted by about 0.25pp in 2017H2, 0.2pp in 2018 and 0.1pp in The growth boost disappears quickly thereafter. Third, the time profile of the corporate tax reduction is similar to the individual tax relief. Annualized growth is boosted by 0.1pp in 2017H2 and 0.2pp in 2018 before the effect dissipates in In each of these scenarios, the unemployment rate is lower and the funds rate rises more quickly to limit the labor market overheating. Core PCE inflation is marginally higher under the tax policies but unchanged with additional infrastructure investment (as this boosts the supply side of the economy). 2. Trump Versus Clinton on Infrastructure, Wilbur Ross and Peter Navarro, October 27, The baseline simulation is based on the FOMC s September SEP and assumes that the FOMC follows an inertial Taylor 1999 rule. We assume backward-looking expectations throughout our simulations. 4. Our specific assumptions for the three scenarios are as follows: (1) private structures investment is boosted by $86bn and corporate income taxes are reduced by $14bn; (2) federal personal income taxes are cut by $250bn; and (3) federal corporate income taxes are reduced by $160bn. We assume that each of these changes occurs in 2017Q3. 12 November 2016 Page 3

4 Exhibit 1: Fiscal Stimulus Boosts Growth Fed Policy: Uncertainty with a Slightly Hawkish Tilt President-elect Trump must nominate a Fed Chair for the term that starts February 2018, and fill two vacancies at the Board at the start of his term, which could result in a significant shift in Fed policy. However, while Mr. Trump was sometimes critical of the Fed as a candidate, his views on monetary policy are unclear; he has expressed support for low interest rates on occasion, but has raised concerns about the effect that low rates have had on asset prices. 5. Many conservative economists favor tighter monetary policy, but Mr. Trump s views appear more nuanced, and we are therefore unsure to what extent he would favor a more hawkish Fed stance after taking office, despite his past criticism of Fed policy. 5. For a more detailed discussion, see Q&A as the Dust Settles, US Daily, November 10, November 2016 Page 4

5 Exhibit 2 simulates two scenarios of how somewhat more hawkish Fed appointments could affect the path of monetary policy and the economy. First, we consider an FOMC that is less cautious than recent Fed policy and pursues a quicker pace of normalization of the funds rate in The tighter policy is only temporary in this scenario, however, as the unemployment rate rises and the FOMC halts the normalization process in 2019 to support faltering growth. Second, we consider an FOMC that perceives the equilibrium funds rate to be 50bp higher than the September SEP. This leads to a tighter path of policy, somewhat slower growth and higher unemployment over the next few years. Exhibit 2: Implications of a More Hawkish Fed 6. Specifically, we reduce the inertia coefficient in the inertial Taylor 1999 rule from 0.85 to November 2016 Page 5

6 Immigration: A More Restrictive Stance Mr. Trump s immigration proposals would likely reduce the flow of immigrants into the United States, by pausing green card issuance for foreign workers, imposing new restrictions on H1-B work visas, and implementing a nationwide e-verify system that would constrain employment of unauthorized immigrants. Exhibit 3 simulates two aspects of Mr. Trump s immigration proposals. First, we model a permanent slowdown in immigration flows, such that the population grows 0.1pp more slowly each year compared with the baseline. 7. Slower population growth reduces potential growth and the economy expands 0.1pp more slowly on a permanent basis. The effects on the rest of the economy are small. Second, we proxy for an e-verify policy that prevents undocumented workers from obtaining employment, prompting 2.5 million people to leave the country over a twoyear period. 8. We find that such a policy would have significantly adverse effects on the economy. Real GDP growth slows by ½-¾pp in as the productive capacity of the economy declines. Moreover, the labor market initially overheats as the supply of labor falls more quickly than the demand for workers. The unemployment rate first declines but then rises sharply as the economy slows. Fed policy tightens more aggressively initially to lean against the overheating in the labor market but later slows the pace of tightening to return the economy to full employment. Trade Policy: A Major Shift In the campaign, Mr. Trump proposed to withdraw from the Trans-Pacific Partnership (TPP), renegotiate NAFTA or withdraw from the agreement, label China a currency manipulator, instruct the US Trade Representative to bring cases against China at the WTO and to use every lawful presidential power to remedy trade disputes if China does not stop its illegal activities including the application of tariffs 9. In terms of explicit changes, Mr. Trump has suggested imposing a 35% tariff on imports from Mexico and a 45% tariff on imports from China. If tariffs on imports from Mexico and China only were raised to 35% and 45% respectively, the average effective US tariff rate would rise by roughly percentage points (pp) from 1.5% to roughly 13%, a level not seen since WWII. 7. Census population projections implicitly assume that immigration flows rise in coming years as the labor market continues to normalize. Assuming this does not occur slows population growth by about 0.1pp. 8. This assumption is based on the effects of Arizona s mandatory e-verify law, as estimated by Lofstrom, Bohn, and Raphael (2011), scaled to the national level. We assume that the reduction in the labor force is larger than implied by the population reduction (as undocumented immigrants are more likely to seek employment) and that the labor force falls more quickly than the population (as undocumented workers first stop working and then leave the country with a lag) November 2016 Page 6

7 Exhibit 3: Immigration Policies Slow Growth Exhibit 4 simulates two trade policy scenarios. 10. In the first scenario, the US raises the average tariff to 13% without retaliation. Higher import prices reduce US imports and real GDP growth is initially a bit higher as a result. Inflation, however, rises meaningfully and higher consumer prices erode real incomes. As a result, consumers cut back spending and real GDP growth slows after a few years. With tariff retaliation, real GDP growth is lower than in the no-tariff baseline throughout the simulation as foreign tariffs weigh on US exports and, as above, consumer spending slows. In both cases core inflation rises to around 2.2%. 10. These simulations follow Daan Struyven, The Economics of Higher Tariffs,, September 30, November 2016 Page 7

8 Exhibit 4: Tariffs Are Inflationary Adding Up Mr. Trump s Proposals We next consider the effect of the combination of these policies, in three scenarios: a full case that combines the fiscal, Fed, trade, and immigration proposals; a benign scenario that includes only the fiscal proposals and an adverse scenario that includes more restrictive trade and immigration policies and a more hawkish Fed. The key assumptions for each scenario are listed in Exhibit November 2016 Page 8

9 Exhibit 5: Three Policy Scenarios Exhibit 6 shows our simulations of these policy packages. We find that the full package boosts growth temporarily via the tax cuts (by about 0.2pp in 2017H2 at an annualized rate) but then slows growth relative to the baseline thereafter (by pp in ). Core PCE inflation rises to 2.3% in late 2019 and the Fed delivers three additional rate hikes by the end of The benign package leads to a pp boost to growth in , as the tax cuts provide a jolt to growth. Inflation is only marginally higher initially but then exceeds the target persistently starting in 2019 as the unemployment rate falls to 4%. The Fed hikes the funds rate 2-3 times more by the end of 2019 to lean against the overheating economy. The adverse policies lead to stagflation, with sharply lower growth and higher inflation. We find that real GDP growth is about 0.8pp lower in and the unemployment rate rises to 5.3%. Core inflation rises quickly, peaking at 2.3% in early The FOMC initially fights inflation with tighter policy but then stops hiking in 2019 in response to faltering growth. 12 November 2016 Page 9

10 Exhibit 6: The Possible Economic Consequences of the New Administration What to Expect We next turn to our own preliminary views on what might be expected under the Trump Administration and the potential economic implications, summarized in Exhibit 7. Exhibit 7: Our Expectations 12 November 2016 Page 10

11 1. Fiscal proposals are likely to be enacted in scaled-down form. We expect that the three proposals noted above will become law, but in scaled-down versions of what has been proposed. Congress is likely in our view to enact tax legislation incorporating some aspects of the reform plans put forth by Mr. Trump and House Speaker Ryan. However, our preliminary view is that revenues might be reduced by around $100bn per year under a scaled-down plan rather than the $400bn per year under the Trump proposal, because we think there is a limit to how much deficit expansion will be tolerated. The focus among congressional Republicans has been as much on tax reform as on a tax cut; the Trump proposal is estimated to cost around twice as much as the House Republican tax reform plan, which itself was offered in the context of a broader House Republican budget proposal that aims to reduce the overall budget deficit by around 3% of GDP. With 52 seats in the Senate, legislation would need near-unanimous support from congressional Republicans to attain even the simple majority that would be required if tax reform were considered through the reconciliation process, which allows passage of certain fiscal legislation in the House and Senate with a simple majority. We expect that the marginal Republican senators will have qualms about significantly expanding deficits given the elevated level of federal debt. We also believe there is a good chance that additional infrastructure funding will be enacted. It is not yet clear, in our view, whether this will be a tax credit-based plan, as Mr. Trump s advisors have laid out, or a more traditional spending program. For now, we assume that an infrastructure program will be enacted that results in an additional $40bn annual investment. We expect that federal discretionary spending will increase slightly, by $10bn. Within this modest net increase we would expect two larger gross changes: we expect the sequestration cuts on defense spending to be largely undone, which could boost spending by $40bn per year, but we also would expect most of this to be offset with reductions in domestic spending, for a small net spending increase. All of these assumptions are likely to change as the discussions progress over coming weeks and months. 2. A slight hawkish shift at the Fed? We are unsure whether and to what extent Mr. Trump would favor a more hawkish Fed stance after taking office. That said, a slight hawkish shift seems most likely and we incorporate this into our central scenario. 3. The pace of immigration looks likely to slow. We are sceptical that much of his immigration plan will be implemented, as most of it would require Congressional approval and finding 60 votes in the Senate for these policies is likely to be difficult. However, the president has more discretion over immigration than many other policy areas, and we expect that the pace of immigration will slow somewhat under the Trump Administration. 4. Trade restrictions would increase, but not by nearly as much as discussed. We are very unsure about how much the Trump Administration will restrict free trade. While we assume that there is a low probability of reaching the top end of the range of the threatened tariffs, we expect that the average tariff applied on US imports is likely to rise. Our expectation is that the new administration might pursue 12 November 2016 Page 11

12 one-third of what Mr. Trump has discussed on the campaign trail; considered as an equivalent average tariff-rate, this would result in a 4pp increase in tariffs on US imports, or roughly the average tariff rate during the Reagan Administration. Exhibit 8 shows simulations of the economic implications of our central expectation of President-elect Trump s policies. 11. Annualized growth is 0.1pp higher than in the baseline in 2017H2 due to the tax cuts but then slows as the growth-adverse aspects of the policy package start to dominate. We find that GDP growth is pp slower in 2018 and beyond. Core inflation is a bit less than 0.1pp higher than in the baseline and the FOMC delivers one additional hike by the end of Exhibit 8: Economic Implications of Our Central Expectation 11. See Exhibit 5 for the specific assumptions we feed into the model. 12 November 2016 Page 12

13 Asymmetric Risks It is important to note that our analysis is subject to considerable uncertainty. Most significantly, our simulations rely on strong assumptions for which of the proposed policies might be adopted and how they are best captured in FRB/US. Moreover, FRB/US is a highly stylized description of reality that does not consider certain conditions that might matter for the economic outlook in practice, including policy uncertainty, changes to regulatory policies, and the global repercussions from Mr. Trump s policies. With these caveats in mind, our analysis points to a few broad conclusions. First, Mr. Trump s policies could boost growth in 2017 and 2018, but are likely to weigh on growth thereafter if trade and immigration restrictions are enacted, or if Fed policy turns more restrictive. Second, core inflation and the funds rate are likely to be higher for the next few years in almost all scenarios which makes the recent reaction of nominal interest rates to the election result look logical. Third, the risks around our base case appear asymmetric. A larger fiscal package could boost growth moderately more in the near term, but a more adverse policy mix would likely lead to a significant slowdown, higher inflation and tighter policy in subsequent years. Sven Jari Stehn Alec Phillips 12 November 2016 Page 13

14 The US Economic and Financial Outlook 12 November 2016 Page 14

15 Economic Releases and Other Events 12 November 2016 Page 15

16 Disclosure Appendix Reg AC We, Jan Hatzius, Zach Pandl, Alec Phillips, Jari Stehn, David Mericle, Elad Pashtan, Daan Struyven, Karen Reichgott and Avisha Thakkar, hereby certify that all of the views expressed in this report accurately reflect our personal views, which have not been influenced by considerations of the firm s business or client relationships. Unless otherwise stated, the individuals listed on the cover page of this report are analysts in Goldman Sachs Global Investment Research division. Disclosures Global product; distributing entities The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy. 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