No surprises from the Fed
Fed Chairman Jay Powell continued to follow the script yesterday, reiterating that the Fed will wait for more fundamental economic data to arrive (rather than relying on forecasts) before scaling back the central bank’s current monetary easing measures.
He also continued to emphasize that the Fed sees the inevitable acceleration in inflation to be transitory, consistent with our own position, and reiterated the Fed will be prepared to look through near-term inflation figures.
Insight’s economic forecasts suggest this means a tapering announcement will arrive by the end of year, tapering will occur over most of 2022 and the stage will be set for an initial rate hike in 2023.
The spotlight symbolically shifts from Powell to Biden
Perhaps fittingly, on the same day all eyes subsequently shifted to President Biden, who last night delivered his first address to a joint session of Congress to cap his first 100 days in office, where he unveiled the $1.8trn ‘American Families Plan’.
As such, markets perhaps paid more attention to Biden than to Powell, symbolic of how the 2010s era of monetary policy dominance is making way for a new 2020s era dominated by fiscal policy.
Monetary policy was the more active tool in addressing the 2008 global financial crisis (save for the initial TARP package) and has since sustained the recovery even as the fiscal deficit shrank. Markets have been trained to read the tea leaves coming from Fed speakers but will now need to shift their focus to the halls of Congress.
In 2020, we saw US monetary and fiscal policy work together in response to the pandemic, with an unprecedented expansion of the Fed’s balance sheet and over $3.3trn in fiscal support from the Trump administration’s CARES act (and subsequent measures), followed by $1.9trn from the Biden Administration’s American Rescue Act. Collectively these measures already amount to half of the spending on the New Deal in GDP terms (Figure 1).
Figure 1: Fiscal stimulus has the potential to exceed the New Deal1
The most aggressive fiscal stimulus plan in at least 50 years
President Biden has additionally proposed a $2.2trn infrastructure program and last night proposed another $1.8trn in social spending for middle- and lower-income families, against $2trn in tax increases on corporations and wealthier, higher-income Americans.
Together, these proposals are the broadest and largest measures since at least the Lyndon B. Johnson Administration in the 1960s.
The effect of fiscal stimulus on GDP
We believe Biden’s proposals will be pared back somewhat. We anticipate about $2.5trn to $3trn in new spending over a decade with about $1trn in tax increases.
We estimate that past stimulus measures and new infrastructure programs will significantly improve US economic growth at least through to 2023. This underpins our forecast for US GDP to end 2022 higher than the pre-COVID trend (Figure 2).
Figure 2: Our estimate of the GDP impact of fiscal stimulus2
As these proposals include more spending than tax increases (year-by-year), we expect the effect will be positive for near-term growth. The spending will also put the US on a path for a sustained fiscal deficit of over $1.5trn per year.
However, while much of this spending is temporary, the tax increases are permanent. That raises the risk that fiscal stimulus-fueled growth will be something of a ‘sugar high’ that fades after 2022, if higher tax rates reduce consumption and they reduce business investment, thereby limiting productivity growth.
While the vaccination drive and economic reopening should help power accelerating economic growth and inflation over the near term, the longer-term outlook remains highly uncertain. We simply have to wait to see if fiscal policy can deliver the lasting economic impact that monetary policy largely failed to over the last decade.
In the coming months, we will be increasingly focusing on negotiations over Biden’s proposals, which will likely have larger market and economic impacts than the Fed’s meetings.