Economists on Wall Street are revising up their estimates of U.S. economic growth over the coming two years due to Washington’s embrace of tax cuts and government spending increases.
Another impact of Washington’s new fiscal stance — larger budget deficits in the years ahead, which could constrain the government’s ability to respond to future downturns or crises.
The final version of a $1.5 trillion tax cut signed into law by President Donald Trump last week provides a slightly more front-loaded round of fiscal stimulus than earlier versions passed by the House and Senate.
Meanwhile, Congress is likely to consider a deal in January to boost federal spending caps and spend heavily on disaster relief to address storms earlier this year. House Republicans have proposed an $81 billion disaster relief bill, almost double the White House’s funding request, though the Senate didn’t take up the measure before the year-end recess.
The combined tax cuts and spending increases are likely to add around 0.7 percentage points to gross domestic product growth in 2018 and another 0.2 percentage points in 2019, said Lewis Alexander, chief U.S. economist at Nomura Securities LLC. He estimates increased government spending could account for half of that boost next year.
“One reason for our relatively optimistic 2018 growth outlook stems from generous, and historically unprecedented, late-cycle fiscal stimulus,” Mr. Alexander said. The change in the federal spending outlook, as opposed to the tax cut, is “a factor not yet fully appreciated by markets.”
Nomura expects the fiscal stimulus to drag on growth after 2019 because it will help induce higher short-term and long-term interest rates.
Economists at Goldman Sachs last week revised up their 2018 and 2019 growth forecasts by 0.3 percentage point and 0.2 percentage point, respectively, to 2.6% and 1.7%. They expect the boost in demand, primarily from increased consumption, to spur more hiring that pushes the unemployment rate down to 3.5% next year, from an earlier forecast of 3.7%, and to 3.3% in 2019, from 3.5%. The unemployment rate, at 4.1% in November, last fell to 3.3% in 1952.
Most economists see the tax cut boosting growth by spurring household consumption, and reductions in corporate tax rates could lift capital spending. Economists at J.P. Morgan see about a 0.2 percentage point increase in the growth rate next year from higher consumer spending and another 0.1 percentage point from business investment. J.P. Morgan expects economic output to grow 2.1% next year.
Congress is working to reach agreement on a government funding deal that would raise automatic spending curbs enacted in 2011. Those caps became more restrictive in 2013 through a process known as sequestration. Bipartisan deals in 2013 and 2015 raised the caps for two years at a time, and the last such deal expired in September.
Goldman economists expect Congress to boost spending caps by $90 billion in 2018 and again in 2019, or by around 7% compared with current levels. Those funding levels don’t include additional spending for disaster relief for parts of the country hit by storms or wildfires.
More stimulus now likely will lead to bigger deficits later. Goldman and J.P. Morgan expect deficits to rise from $664 billion in the fiscal year ended September, or around 3.4% of GDP, to $1 trillion, or 5% of GDP, in 2019.
A shift toward higher budget deficits during periods when the economic expansion is well advanced stands in contrast to recent historical experience. Typically, budget deficits fall when the economy expands and rise when it contracts.
Moreover, few on Wall Street expect this stimulus-fueled short-term acceleration to translate into higher long-term growth, the key justification Republicans advanced for cutting personal and business tax rates. Goldman, for example, still sees long-run potential growth at 1.75%, in line with that of Federal Reserve officials. Congress’ nonpartisan scorekeeper, the Joint Committee on Taxation, similarly sees almost no increase in growth after 10 years.
When the unemployment rate reached its lowest point during the expansions that ended in 2001 and 2007, for example, the U.S. ran a budget surplus of 2.3% and a deficit of 1.1% of GDP, respectively. During the current expansion, deficits reached their lowest point in 2015, at around 2.5% of GDP, before turning higher.
If the deficit is high, that could leave the government less fiscal room to respond should the economy turn toward recession.
Economists at Goldman and J.P. Morgan expect stronger growth, including from the new stimulus, to lead Federal Reserve officials to raise rates four times next year. At their meeting earlier this month, officials penciled in three rate increases.
Higher interest rates in the U.S. and abroad, as central banks in Europe consider pulling back easy money programs, could slow one favorable tailwind that fiscal policy makers enjoyed in recent years from lower interest costs.
Source: Dow Jones