Amid all the political craziness at home and around the world, you may not have noticed that one bit of traditional policy wisdom is making a comeback. The biggest development for 2017 could be that ‘austerity as stimulus’ is out and ‘stimulus as stimulus’ is back in a big way.[1]
Following the election in Japan, Prime Minisiter Abe has rejected the seldom-mentioned fourth arrow in his stimulus quiver—big tax increases immediately following conventional stimulus. Following the Brexit vote, new Prime Minister May has dropped the goal of fiscal surplus by 2020 and the Chancellor of the Exchequer has declared a readiness to reset U.K. fiscal policy. China never drank the austerity Kool-aid and continues to declare a willingness to blend fiscal stimulus with structural reform to attain its economic goals.
But most remarkable of all may be the U.S. Candidate Trump is promising large tax cuts. His spending plans are, to be generous, not entirely clear, but it is hard to imagine this populist demagogue not spreading the spending around. And good luck getting the Mexicans to pay for that wall. On the other hand, if the election is a win for the Democrats, which at this point appears to be the most likely outcome, we get a Democratic President and much less deadlocked Capitol Hill. In this case, we’ll very likely see large stimulus.[2]
The main scenario in which the U.S. does not join the shift to fiscal stimulus is if Hillary wins the presidency, but fiscal conservatives gain ground in the Congress. This scenario seems pretty unlikely to us.
Thus, for varied reasons, the U.S., China, the U.K., and Japan may all be set for additional stimulus. That covers pretty much everyone. Well, everyone except for the euro area—the economies that may be most in need of stimulus.
Fleshing Out U.S. Stimulus Chances
Political forecasters now give Trump somewhere between a 20% and 40% chance of winning in November. It is all but impossible to imagine a scenario in which Trump triumphs and the Senate falls into Democratic hands. Thus a Trump victory puts all of Washington into GOP hands. That translates to 20 to 40 percent chance of HUGE stimulus.
If Clinton wins, she is not guaranteed a situation that will allow her to enact legislation. But Republicans hold 24 of the 36 Senate seats up for reelection this coming November. Handicappers, at the moment suggest that the Senate looks like a toss-up, while the House is a long shot for the Democrats. But conditional on Hillary taking the White House, there are good odds on the Democrats taking the Senate and making significant gains in the House.
To us, this suggests that there are very strong odds that either Donald or Hillary will be in a position to deliver big fiscal stimulus of one kind or another. Clinton’s plans couple infrastructure spending with tax increases on the wealthy. Of course, a classic political route to Keynesian stimulus is to spend the money but skip the tax increases. But even if the tax increases happen, the net will be fiscal stimulus, so long as those paying the higher taxes have a low marginal propensity to consume.[3]
Overall then, the big economic trend is to fiscal stimulus. While our expertise runs more toward macroeconomics than politics, it is hard not to think that this shift toward fiscal stimulus is a consequence of difficult economic times for those of middle and lower incomes leading to political upheaval as reflected in Brexit and Trump, and then leading (perhaps surprisingly) back to a classic approach to jump starting economies. We’ll be discussing what this may mean for monetary policy in future posts.
Notes:
1. As we published, we noted that Michael Mackenzie in the FT is also arguing that stimulus is in. [back]
2. Larry Summers, a key player in the Bill Clinton and Obama administrations has offered much commentary in the past few years arguing that only fiscal stimulus can lift the world out of its pallor. [back]
3. That, in turn, is highly likely, as any tax increases would be targeted to the best off. [back]