United States Budget Balance and Real GDP Growth Rate: Evolutions and Forecasts
Sources: Congressional Budget Office, Oxford Economics, Beyond Ratings
While this fiscal expansion could improve the GDP growth rate in the short term, it will have no effect on potential growth. The Congressional Budget Office forecasts a GDP growth rate below the potential output from 2021. Indeed, improving the potential growth requires higher population growth and/or higher productivity growth. None of these will be impacted by Trumponomics.
Most important, this pro-cyclical policy with tax cuts will only benefit higher income households. Indeed, as underlined by a recent study, taxes for the three bottom quintiles will increase due to the Tax Cuts and Jobs Act Agreement, while taxes cuts for the 5 last centiles will be significant. This increasing budget deficit will thus increase the public debt and notably feed the rising income of the richest. The increasing inequality has led to an exponential growth of private debt in the 2000s which caused that lower and middle income have run into debt in order to maintain their purchasing power. Thus, the increase in inequalities could again cause a financial bubble as it happened in the global financial crisis.
This pro-cyclical fiscal policy will also have impacts on the sovereign yield curve and FED’s monetary policy. Indeed, this increase of public deficit has two financial adjustment mechanisms: by the interest rate and by the exchange rate. First, an adjustment of the sovereign interest rates can occur through faster hikes from FED or by higher risk premiums. Hence, this increase of interest rate attracts needed capital (foreign and domestic) to finance the government public deficit. Secondly, a possible adjustment could come through an exchange rate adjustment. Thus, as increasing public deficit is financed by an increasing external debt, US dollars denominated external debt value could increase due to a weakening exchange rate.
United States Government 2Y and 10Y Rates
Sources: Source: Thomson Reuters, Beyond Ratings
The first financial impacts on yield curve can already being observed: at this moment, the spread between long-term (10-year) and short-term (2-year) rates on the United States is about only 43 basis points. As underlined by the chart above, a flattering yield curve was observed just before previous financial crises (in 2000 and in 2006-2008).
Thus, while this pro-cyclical fiscal policy aims at improving US economic activity on the medium term, it could sow the seeds of the next global financial crisis…
Gabriela Aguilera-Lizarazu and Thomas Lorans