Sunday, February 18, 2018

Consequences, Intended and Otherwise: "Make The Rest of the World Great Again"

From the Council on Foreign Relations:

Trump’s Tax Success Is at the Expense of His Trade Agenda
It looks like a combination of tax cuts and spending increases will raise the U.S. fiscal deficit by about 2 percentage points of GDP (that’s the number Krugman used; Goldman’s US economics team puts the increase in the fiscal deficit between fiscal 2017 and fiscal 2019 at 1.7 percent of GDP). The IMF’s standard coefficient relating changes in the fiscal balance to changes in the external balance would imply that the U.S. current account deficit will increase by about a percentage point of GDP—so rise to around 4 percent of GDP.

There are a few reasons to think that this might be a bit high.

The U.S. is globally speaking, a relatively closed economy. Imports have increased at about a quarter of the pace of domestic demand over the course of the recovery from the global (or north Atlantic) crisis. So the external spillovers from a U.S. fiscal stimulus might be smaller than the global norm. *
A high portion of the tax cut will go toward buybacks, special dividend payments, and the like, and a high portion of those payments may be saved not spent. This isn’t a fiscal stimulus designed for maximum impact on demand.

And, well, the IMF’s coefficients have a whole lot of implicit assumptions baked into them—assumptions that may not hold this time. In most cases a fiscal loosening changes the stance of monetary policy, and those changes in the stance of monetary policy in turn drive some change in the exchange rate. But, if the Fed doesn’t end up tightening more, or if the dollar doesn’t in fact appreciate as the Fed tightens, the impact of the fiscal expansion on the trade deficit may be smaller than the simple application of the IMF’s model would predict.

But there are a couple of factors that could work the other way too.

The closer the economy is to operating at capacity, the more the demand created by the stimulus may bleed out to the rest of the world. That is arguably what happened in q4 of 2017. Domestic demand growth accelerated, with the contribution from demand to GDP growth rising from around 2.5 percent to above 3.5 percent. But an unusually big chunk of that was spent on imports—over 50 percent. **
Contributions to U.S. GDP Growth: Demand Versus Exports
If that pattern continues, The U.S. would get stuck with the debt while the United States’ big trading partners would get the stimulus. A poorly timed fiscal expansion thus could end up making China, Korea, Japan, Germany, and the other big exporting economies great.
Aside from trade there is an “income” channel. Or more specifically, a “higher interest rate on a big stock of external debt” channel....

HT: the attached note says FTAV twitter sidebar Feb-16 but I am at a loss to say whose tweet, apologies to the tipster.