A great deal has already been written on the makeup of the Trump coalition, with fraught debate about whether or not he won over “globalisation’s losers” (and an even more fraught debate about whether such losers are an inevitable byproduct of globalisation or simply a result of bad US domestic policy-making).
Many liberals have been taking comfort from the fact that a majority of poorer voters turned out for Clinton, with people being 10 per cent more likely to vote for Trump if their income is above $50,000. We might have lost, but at least this wasn’t a revolt of our core vote goes the argument.
This is a bad argument. Yes the rich are always more likely to vote Republican (they teach this in US politics 101 I believe) but what matters is that the move towards Trump and away from the Democrats was entirely amongst middle and low income voters, with a huge 16 percentage point net move for instance amongst those with incomes under $30,000. This change is a key reason why a Republican, rather than the first woman President, will be in the White House in two months’ time.
That gives a broad two part “Trump Coalition” of traditional Republican voters PLUS a smaller cohort of the “left behind”.
I’m a firm believer that in the longer run political economy matters for macroeconomic policy. This summer I wrote post on how unusually low bond yields, were building the political economy case for a shift towards a fiscal policy:
…whilst the macroeconomic argument for more active fiscal policy has always been strong, the political economy conditions that may drive it are becoming clearer. Aggressive deficit-financed state spending may (unusually) create two sets of winners — the workforce who benefit from faster growth, tighter labour markets and stronger real income growth and the mass of (relatively) small scale rentiers who would benefit from higher rates.
The markets seem to have decided that this will indeed now happen — stocks up, commodities up, bonds down. Indeed, the markets seem to have decided that President Trump will be a relatively normal President, even if candidate Trump was a deeply unusual candidate. I’m not so sure. To adapt a phrase: “demagogues can stay irrational longer than you can stay solvent”.
Still, as a base case a meaningful fiscal easing seems likely. Real estate developers like building stuff after all, Republicans are pretty keen on cutting taxes and this will be a lot easier to get through Congress for a Republican President. This is what incoming Republican Presidents do — they cut taxes in a meaningful way and many supposed deficit hawks use back of the napkin logic to tell themselves “these tax cuts will pay for themselves”. (Actually they won’t).
Infrastructure is a harder sell but offers plenty of pork-barrel potential, which should grease the wheels a bit. (As an aside here, those pointing to the existence of many “sound-money/fiscal hawk” types in the GOP caucus would do well to remember that Trump captured the nomination and now the White House by working around them. This Bloomberg piece from two weeks ago — which looks very prescient in many ways — is especially interesting on his plans to reshape the party).
So far then, so straight forward: new administration eases fiscal policy, demand rises, labour market tightens further , inflation picks up, rates rise — political economy boxes ticked.
But I think it is actually far from straight forward. Implicit in that line of analysis are assumptions about the Fed’s reaction functions and about productivity growth that need to be questioned. And, crucially, it misses the biggest shift that Trump’s Presidency could bring about — a rejection of “globalisation”/economic openness.
I’m not sure if Trump has an ideological position and he certainly doesn’t have a coherent set of practical polices but the defining feature of his run so far as been the notion of “America First”. I think that needs to be taken seriously as his governing principle.
I’ve been thinking about through the lens of two trilemmas.
(The idea of a trilemma here is that a policymaker can choose only two of the three variables).
America First implies dumping “deep economic integration” in favour of the nation state and democratic politics. A shift from “the golden straightjacket” to the “Bretton Woods compromise”.
Of course neither label on Rodrik’s original chart here actually really works for the US.
The dollar’s role as the world’s primary reserve currency has historically loosened the ties of the straight jacket — so-called exorbitant privilege. And looking ahead, Trump seems unlikely to call a G-20 meeting in the Mount Washington Hotel. He isn’t talking about creating a new international economic order which perseveres policy freedom for each member — he is talking about unilaterally asserting US policy freedom, or to put it another way America First.
That will have consequences. The international consequences are potentially very serious and worthy of another post at some point, but let’s stick with the domestic ones for the moment.
The very sharp Karthik Sankaran has been arguing for months (originally in the context of Brexit) , that populist attempts to “take back control” could counter-intuitively and paradoxically leave policy-makers with less control.
In macroeconomic terms: lowering your ability to import disinflation from the rest of the globe could worsen the trade-offs involved in any particular fiscal/monetary policy mix.
I doubt President Trump (and it still feels weird typing that) will enact the whole promised agenda of slashing migration, deporting millions of illegal migrants, slapping tariffs on China and Mexico and punishing companies for outbound FDI. But I have no doubt that he will at least try and implement some of it. And to a greater or lesser degree that will be inflationary.
Add a meaningful fiscal stimulus to the fact that US labour markets are already tightening, that commodities have rebounded and that monetary policy is still set to very easy and it isn’t hard to see a pick up in inflation.
Which takes us straight to the second trilemma. Deutsche Bank’s 2015 “new impossibility trinity” as amended by Toby Nangle.
Deutsche Bank have argued that only two of high corporate profits, decent (i.e. historically normal) nominal wage growth and steady inflation are possible as long productivity growth remains exceptionally weak.
As their excellent chart on the US shows — productivity growth has always been a crucial component of nominal wage growth — contributing more than half of the nominal increase in the 1990s and 2000s.
The usual thing to do when forecasting now is to assume some rebound in productivity growth to more normal rate. But for me, the lesson of watching the UK data since 2009 has been that it is safer to assume it will remain weak — at least in the short term. (A long-ish Guardian piece from me on this earlier this year).
So assuming productivity growth remains weak, from a political economy perspective (in the medium term anyway) the “money illusion” point on the impossibility trinity is where the President would want to be of any of those three options. That means higher inflation.
(Again, productivity growth would break policymakers out of this trilemma — Toby Nangle (in the post linked to above) gives a good case for medium term optimism. But I’m not sure we can rely on it in the short term).
So the question really becomes, will the Fed tolerate higher (above 2% inflation) when fiscal stimulus kicks in? A choice that will have to be made against a backdrop of America First-style policies very possibly raising the expected rate of inflation at any given level of demand.
That’s a question, which as Kit Juckes put it on Twitter last night, will determine the direction of the dollar.
And it’s the question investors are starting to ask. As Bloomberg’s Joe Weisenthal put it in the Bloomberg Markets email today:
The most interesting thing, however, is not what’s going on in equities, but what’s going on in interest rates and inflation expectations. U.S. 10-year yields are above 2 percent, their highest level since January as markets expect Trump to be fiscally liberal and drive up inflation… The economist Lars Christensen writes that investors are betting that Trump will be an unreconstructed Keynesian and that there won’t be an aggressive monetary offset from central banks — at least for now. There could, however, be trouble down the road if inflation were to truly run so “hot” that the Fed felt the need to take action in order to retain its credibility and its mandate. Christensen warns — and not without good reason — that: “Knowing Trump’s temperament and persona that could cause a conflict between the Fed and the Trump administration.”
I’m sure the Fed would be comfortable with a inflation overshoot in the short term- Yellen has speculated recently about the (convincing!)case for running the economy hot for a period.
But that speech was before the prospect of America First style policies risked worsening the inflation/growth trade off.
Adam Posen argued in late September, that Trump’s domestic economic polices would basically see a re-run of the early Reagan years.
How does the Federal Reserve react?
Assume clear majority of current FOMC believes economy at risk of overheating
• Fiscal stimulus sharply raises growth and inflation projections in the Trump scenario — Do they react to the long-term budget implications? — Do they assume further labor supply reduction?
• Trump trade measures temporarily raise inflation and puts upward pressure on $
• A remake of Reagan-Volcker worse than the original is the likely outcome
I’m not so sure.
Leaving aside that inflation is unlikely to run as hot as what Volcker inherited, I’m just not sure the political economy conditions (which arose in a set of circumstances incredibly well documented by Brad DeLong in this paper) yet exist for this type of reaction.
The need to hold down inflation (even at a steep price in terms of job losses) certainlycan be the basis of a winning political coalition. But assembling that alliance takes a good few years of rising prices. In the short run (say, between now and 2020) I suspect the electorate — and the President — would prefer to “enjoy” money illusion, both for wage growth and nominal rates for the retired.
In other words, Trump — the former real estate developer — is likely to favour a Burns-esque Fed to a Volcker-esque one.
Things are thankfully unlikely to reach the point they did in the 1970s, when as Delong writes:
Making Arthur Burns and the Federal Reserve sensitive to White House concerns was a subject of conversation in Nixon’s White House in 1970 and 1971. “What shall I say to Arthur?’ Nixon would ask. “Ask him if he shares the President’s objective of full employment by mid-1972,” George Shultz suggested. Paul McCracken added, “If he says yes, say that the Fed’s monetary path can’t and won’t bring us to that outcome” (Ehrlichman 1982, 251). Such pressures must have made Burns sensitive to White House concerns, and may be the source of an axiom in the Federal Reserve’s institutional memory that the Federal Reserve is better off having fewer rather than more direct contacts with the White House staff.
I very much doubt a Trump administration would be as clumsy as to apply this sort of direct pressure to the Yellen Fed — and doubt even more that it would work. But his Fed appointments will be key.
The risk of monetary policy becoming politicised is both high and underappreciated. As @nosunkcosts put it a few weeks ago (selected highlights of an excellent tweet storm below):
The Fed’s independence is hard won and it has the institutional strength to look after itself for a while but a messy fight over monetary policy/Fed appointments does feel very likely at this juncture.
A policy mix (fiscal/monetary/economic openness) that delivers decent nominal wage growth, stronger growth and higher nominal rates would suit Trump as President. The Fed though is likely to be far less keen.
Trump’s choices on the globalisation trilemma make his choices on the impossibility trilemma more acute and potentially lay the groundwork for a battle between the administration and the Federal Reserve over economic policy. That could be one of the crucial fights to watch in the next four years.
Many liberals have been taking comfort from the fact that a majority of poorer voters turned out for Clinton, with people being 10 per cent more likely to vote for Trump if their income is above $50,000. We might have lost, but at least this wasn’t a revolt of our core vote goes the argument.
This is a bad argument. Yes the rich are always more likely to vote Republican (they teach this in US politics 101 I believe) but what matters is that the move towards Trump and away from the Democrats was entirely amongst middle and low income voters, with a huge 16 percentage point net move for instance amongst those with incomes under $30,000. This change is a key reason why a Republican, rather than the first woman President, will be in the White House in two months’ time.
That gives a broad two part “Trump Coalition” of traditional Republican voters PLUS a smaller cohort of the “left behind”.
I’m a firm believer that in the longer run political economy matters for macroeconomic policy. This summer I wrote post on how unusually low bond yields, were building the political economy case for a shift towards a fiscal policy:
…whilst the macroeconomic argument for more active fiscal policy has always been strong, the political economy conditions that may drive it are becoming clearer. Aggressive deficit-financed state spending may (unusually) create two sets of winners — the workforce who benefit from faster growth, tighter labour markets and stronger real income growth and the mass of (relatively) small scale rentiers who would benefit from higher rates.
The markets seem to have decided that this will indeed now happen — stocks up, commodities up, bonds down. Indeed, the markets seem to have decided that President Trump will be a relatively normal President, even if candidate Trump was a deeply unusual candidate. I’m not so sure. To adapt a phrase: “demagogues can stay irrational longer than you can stay solvent”.
Still, as a base case a meaningful fiscal easing seems likely. Real estate developers like building stuff after all, Republicans are pretty keen on cutting taxes and this will be a lot easier to get through Congress for a Republican President. This is what incoming Republican Presidents do — they cut taxes in a meaningful way and many supposed deficit hawks use back of the napkin logic to tell themselves “these tax cuts will pay for themselves”. (Actually they won’t).
Infrastructure is a harder sell but offers plenty of pork-barrel potential, which should grease the wheels a bit. (As an aside here, those pointing to the existence of many “sound-money/fiscal hawk” types in the GOP caucus would do well to remember that Trump captured the nomination and now the White House by working around them. This Bloomberg piece from two weeks ago — which looks very prescient in many ways — is especially interesting on his plans to reshape the party).
So far then, so straight forward: new administration eases fiscal policy, demand rises, labour market tightens further , inflation picks up, rates rise — political economy boxes ticked.
But I think it is actually far from straight forward. Implicit in that line of analysis are assumptions about the Fed’s reaction functions and about productivity growth that need to be questioned. And, crucially, it misses the biggest shift that Trump’s Presidency could bring about — a rejection of “globalisation”/economic openness.
I’m not sure if Trump has an ideological position and he certainly doesn’t have a coherent set of practical polices but the defining feature of his run so far as been the notion of “America First”. I think that needs to be taken seriously as his governing principle.
I’ve been thinking about through the lens of two trilemmas.
(The idea of a trilemma here is that a policymaker can choose only two of the three variables).
America First implies dumping “deep economic integration” in favour of the nation state and democratic politics. A shift from “the golden straightjacket” to the “Bretton Woods compromise”.
Of course neither label on Rodrik’s original chart here actually really works for the US.
The dollar’s role as the world’s primary reserve currency has historically loosened the ties of the straight jacket — so-called exorbitant privilege. And looking ahead, Trump seems unlikely to call a G-20 meeting in the Mount Washington Hotel. He isn’t talking about creating a new international economic order which perseveres policy freedom for each member — he is talking about unilaterally asserting US policy freedom, or to put it another way America First.
That will have consequences. The international consequences are potentially very serious and worthy of another post at some point, but let’s stick with the domestic ones for the moment.
The very sharp Karthik Sankaran has been arguing for months (originally in the context of Brexit) , that populist attempts to “take back control” could counter-intuitively and paradoxically leave policy-makers with less control.
In macroeconomic terms: lowering your ability to import disinflation from the rest of the globe could worsen the trade-offs involved in any particular fiscal/monetary policy mix.
I doubt President Trump (and it still feels weird typing that) will enact the whole promised agenda of slashing migration, deporting millions of illegal migrants, slapping tariffs on China and Mexico and punishing companies for outbound FDI. But I have no doubt that he will at least try and implement some of it. And to a greater or lesser degree that will be inflationary.
Add a meaningful fiscal stimulus to the fact that US labour markets are already tightening, that commodities have rebounded and that monetary policy is still set to very easy and it isn’t hard to see a pick up in inflation.
Which takes us straight to the second trilemma. Deutsche Bank’s 2015 “new impossibility trinity” as amended by Toby Nangle.
Deutsche Bank have argued that only two of high corporate profits, decent (i.e. historically normal) nominal wage growth and steady inflation are possible as long productivity growth remains exceptionally weak.
As their excellent chart on the US shows — productivity growth has always been a crucial component of nominal wage growth — contributing more than half of the nominal increase in the 1990s and 2000s.
The usual thing to do when forecasting now is to assume some rebound in productivity growth to more normal rate. But for me, the lesson of watching the UK data since 2009 has been that it is safer to assume it will remain weak — at least in the short term. (A long-ish Guardian piece from me on this earlier this year).
So assuming productivity growth remains weak, from a political economy perspective (in the medium term anyway) the “money illusion” point on the impossibility trinity is where the President would want to be of any of those three options. That means higher inflation.
(Again, productivity growth would break policymakers out of this trilemma — Toby Nangle (in the post linked to above) gives a good case for medium term optimism. But I’m not sure we can rely on it in the short term).
So the question really becomes, will the Fed tolerate higher (above 2% inflation) when fiscal stimulus kicks in? A choice that will have to be made against a backdrop of America First-style policies very possibly raising the expected rate of inflation at any given level of demand.
That’s a question, which as Kit Juckes put it on Twitter last night, will determine the direction of the dollar.
And it’s the question investors are starting to ask. As Bloomberg’s Joe Weisenthal put it in the Bloomberg Markets email today:
The most interesting thing, however, is not what’s going on in equities, but what’s going on in interest rates and inflation expectations. U.S. 10-year yields are above 2 percent, their highest level since January as markets expect Trump to be fiscally liberal and drive up inflation… The economist Lars Christensen writes that investors are betting that Trump will be an unreconstructed Keynesian and that there won’t be an aggressive monetary offset from central banks — at least for now. There could, however, be trouble down the road if inflation were to truly run so “hot” that the Fed felt the need to take action in order to retain its credibility and its mandate. Christensen warns — and not without good reason — that: “Knowing Trump’s temperament and persona that could cause a conflict between the Fed and the Trump administration.”
I’m sure the Fed would be comfortable with a inflation overshoot in the short term- Yellen has speculated recently about the (convincing!)case for running the economy hot for a period.
But that speech was before the prospect of America First style policies risked worsening the inflation/growth trade off.
Adam Posen argued in late September, that Trump’s domestic economic polices would basically see a re-run of the early Reagan years.
How does the Federal Reserve react?
Assume clear majority of current FOMC believes economy at risk of overheating
• Fiscal stimulus sharply raises growth and inflation projections in the Trump scenario — Do they react to the long-term budget implications? — Do they assume further labor supply reduction?
• Trump trade measures temporarily raise inflation and puts upward pressure on $
• A remake of Reagan-Volcker worse than the original is the likely outcome
I’m not so sure.
Leaving aside that inflation is unlikely to run as hot as what Volcker inherited, I’m just not sure the political economy conditions (which arose in a set of circumstances incredibly well documented by Brad DeLong in this paper) yet exist for this type of reaction.
The need to hold down inflation (even at a steep price in terms of job losses) certainlycan be the basis of a winning political coalition. But assembling that alliance takes a good few years of rising prices. In the short run (say, between now and 2020) I suspect the electorate — and the President — would prefer to “enjoy” money illusion, both for wage growth and nominal rates for the retired.
In other words, Trump — the former real estate developer — is likely to favour a Burns-esque Fed to a Volcker-esque one.
Things are thankfully unlikely to reach the point they did in the 1970s, when as Delong writes:
Making Arthur Burns and the Federal Reserve sensitive to White House concerns was a subject of conversation in Nixon’s White House in 1970 and 1971. “What shall I say to Arthur?’ Nixon would ask. “Ask him if he shares the President’s objective of full employment by mid-1972,” George Shultz suggested. Paul McCracken added, “If he says yes, say that the Fed’s monetary path can’t and won’t bring us to that outcome” (Ehrlichman 1982, 251). Such pressures must have made Burns sensitive to White House concerns, and may be the source of an axiom in the Federal Reserve’s institutional memory that the Federal Reserve is better off having fewer rather than more direct contacts with the White House staff.
I very much doubt a Trump administration would be as clumsy as to apply this sort of direct pressure to the Yellen Fed — and doubt even more that it would work. But his Fed appointments will be key.
The risk of monetary policy becoming politicised is both high and underappreciated. As @nosunkcosts put it a few weeks ago (selected highlights of an excellent tweet storm below):
The Fed’s independence is hard won and it has the institutional strength to look after itself for a while but a messy fight over monetary policy/Fed appointments does feel very likely at this juncture.
A policy mix (fiscal/monetary/economic openness) that delivers decent nominal wage growth, stronger growth and higher nominal rates would suit Trump as President. The Fed though is likely to be far less keen.
Trump’s choices on the globalisation trilemma make his choices on the impossibility trilemma more acute and potentially lay the groundwork for a battle between the administration and the Federal Reserve over economic policy. That could be one of the crucial fights to watch in the next four years.
