Over the weekend, I outlined the rather stark economic choice facing Americans as they go to the polls (or mail in their ballots) for what promises to be an epochal election.
To briefly recapitulate, the Trump administration is generally in favor of more virus relief but beyond that, the ramifications of spending another four years operating under supply-side economics thinly disguised as populism should be obvious.
A weaker fiscal impulse (i.e., a pivot to fiscal retrenchment to pacify budget hawks) will put the onus for sustaining the recovery squarely on monetary policy. That will result in a prolonged period of financial repression and asset price inflation, with the same predictable results: Massive gains for the rich in whose hands those assets are overwhelmingly concentrated, and meager income opportunities for everyone else, as rates on cash savings stay glued at zero and bonds yield next to nothing. The preservation of a tax regime that favors corporations and the wealthy will exacerbate that dynamic, especially if conservative aspirations like indexing capital gains to inflation are realized.
Deutsche Bank’s Aleksandar Kocic described the alternative. “A Democratic sweep, on the other hand, means more egalitarian distribution with possibly more deficit spending and stronger impact on growth”, he wrote, in a note out late last week.
“As such, it implies a possibility of a shorter period of financial repression and emergence of an active Fed on the horizon as rebound of growth accelerates reflation and frees the Fed’s hand to adjust policy to the new realities”, Kocic added.
On Tuesday, Goldman underscores some of these points.
In a new note, the bank simulates five policy changes from a Democratic sweep: An increase in government spending, an increase in transfer payments, an increase in the personal tax rate, an increase in the corporate tax rate, and “a rollback of US tariff increases that President Trump implemented, which we assume would be accompanied by a rollback of foreign retaliatory tariffs”. Goldman says what actually makes it into law would likely be a watered down version of Biden’s proposals.
For the Fed, Goldman assumes policy follows the new framework, defined by average inflation targeting and outcome-based forward guidance which specifically ties future rate hikes to the realization of (not just progress towards) labor market and price goals.
The following (from Goldman’s note) will be a bit tedious for casual readers, but it’s important to understand the specifics of their assumptions in this case:
We interpret this to imply liftoff thresholds of a 4.1% unemployment rate, the FOMC’s estimate of the longer-run rate, and a 2.1% inflation rate, high enough to inspire confidence that inflation will stay above 2%. After liftoff, we impose an average inflation targeting rule that treats the employment gap asymmetrically by responding only to shortfalls but not overshoots of the longer-run rate, and that adds the cumulative inflation shortfall since the start of the 2020 recession as an additional term in the policy rule. The new framework implies a later liftoff and a slower pace of rate hikes than the old framework would have.
In order to keep folks engaged, I’ll eschew the temptation to delve into the details in favor of simply saying that the bank simulates the deviation from a baseline (where the baseline is derived from those policy assumptions) engendered by Biden’s proposals (as they stand today) and Goldman’s expectations for what would actually make it into law.
It won’t surprise you to learn that Goldman’s simulations result in faster liftoff for the Fed (i.e., normalization is brought forward) under Democratic government.
Specifically, PCE inflation would be 0.37pp and 0.22pp higher through 2025, which “pulls forward the point at which core PCE inflation breaches the assumed 2.1% threshold for liftoff by about two years under the Biden proposals and a little less under the assumed legislation”, the bank writes, before crystallizing it for anyone who may need a more straightforward explanation:
Put more simply, a blue wave might result in funds rate liftoff in 2023, instead of our current forecast of early 2025.
This is where things get challenging for those looking to reconcile the unreconcilable. There is a large contingent of commentators who habitually lament financial repression in all its various manifestations and also deride the extent to which the Fed is inflating bubbles, while simultaneously insisting that a more redistributive tax regime and looser fiscal policy will invariably lead to some kind of financial ruin.
The point of the weekend piece (linked above) was essentially to reiterate that you can’t have it both ways anymore. Either you want monetary policy normalization or you don’t, and if you do, then a concurrent (and persistent) fiscal impulse is necessary to make that possible.
We had this conjuncture in 2017/2018, but the fiscal stimulus was decidedly supply-side in nature. The result was a hawkish Fed hiking into an unsustainable economic sugar high, which is all supply-side stimulus can ever hope to engineer. Ultimately, the Fed overtightened, the sugar high waned, and markets collapsed in Q4 2018, with the government shutdown adding insult to injury.
In their piece, Goldman goes on to say that “following liftoff, the policy packages imply additional rate hikes at a somewhat quicker pace than without stimulus… because the more positive output gap continues to gradually boost inflation… and because both packages accelerate the recovery early on, resulting in a more limited inflation shortfall over the next couple of years and less need to keep policy easy later to permit a compensating overshoot”.
Generally speaking, there are two ways this can be construed as a “bad” outcome. One is by suggesting that hyperinflation is imminent in the US. If that’s your story (and you intend to stick to it) then there’s no need to have a discussion — just buy gold, I guess.
The other way to suggest the above represents a “bad” outcome is to say you actually don’t want Fed hikes — that you prefer to live under perpetually easy monetary policy acting with little to no complimentary fiscal impulse, because that drives up financial asset prices and limits the scope for policy to erode those gains via higher inflation.
Of course, no one will admit they want that, because doing so would be an admission of hypocrisy and complicity in a policy regime where the biggest and most vocal critics are usually the people who benefit from it the most.