New York: The strong US economic growth of mid-2018 — the stock market soared, hiring picked up and consumer spending surged — reflected, in part, the benefits of a boost in fiscal stimulus.
The Trump administration pushed for, and got a huge tax cut, and then, to give the economy even more oomph, US Congress passed budgets for fiscal years 2018 and 2019 that included a rare bipartisan agreement to juice spending for defence and social programmes. But the effects of all that stimulus are starting to wane, and problems are emerging that make a recession in 2020 look more and more likely.
Over the next few days, as American companies report earnings for 2018, the effects of all that spending will be clear: Corporate tax cuts increased profits last year, and those results will be hard to beat this year. The tax cuts were supposed to trigger an increase in investment, productivity growth and profit margins — which might have nourished future growth — but that failed to materialise.
Instead, big corporations authorised a record-breaking $1 trillion in stock buy-backs in 2018, according to Goldman Sachs, and made good on those announcements by returning their tax cuts to shareholders. Sure, the buy-backs bumped up stock prices, but that proved fleeting, especially after the tax increases, supply-chain disruptions and uncertainty associated with tariffs and trade tensions.
Individuals, too, are likely to be disappointed this year, when tax refunds as a result of the 2017 tax legislation fail to meet expectations. Many people did not withhold enough to accommodate changes in the laws, a confusion that is compounded by understaffing at the Internal Revenue Service and delays created by the just-ended government shutdown.
Americans count on those refunds to pay down debt and finance big-ticket purchases. When that money isn’t forthcoming, they may be disappointed and angry.
Finally, the US isn’t likely to see any further increase in government spending — an important source of last year’s stimulus — in the current fiscal year. The Republicans have regained religion about deficits since they blew a hole in the budget with tax cuts, while former Tea Party Republicans are looking for cuts to agencies and social programmes.
The result is that federal spending is expected to decline later this year, and those losses will compound as we move into 2020.
The length of the shutdown — 35 days — is also important, as federal employees try to catch up with assignments they missed during that time. The only benchmark for comparison was the 21-day shutdown from December 1995 to January 1996.
Then, as now, contractors were especially hard hit; it can take weeks or months to get up and running again. Some of their losses were never recouped. But in 1995 and early 1996, the Federal Reserve made a cut to short-term interest rates, giving an extra lift to the economy once the shutdown ended.
The tech bubble was also forming. The subsequent jump in financial markets was so powerful that it prompted Alan Greenspan, the Fed chairman at the time, to worry openly about “irrational exuberance”.
No one is really worried about exuberance, rational or otherwise, right now. Government spending is playing out, the Fed has been sidelined and doesn’t have a lot of room to cut rates, global growth is slowing and political leaders at home and abroad are at one another’s throats.
All that has raised the risk of a 2020 recession.
Before that happens, Congress and the president should do whatever they can to sustain economic growth, while we still have growth to sustain. I have been a fiscal hawk my entire professional career, and I don’t usually support deficits in times of prosperity.
But there is a small window of opportunity for policymakers to act, while interest rates remain low and we have some wiggle room on taxes. Once a slowdown begins, tax revenues fall, automatic stabilisers such as unemployment insurance kick in, and the need for social services and short-term stimulus intensifies.
Then, it may be more difficult to carry out the large-scale investments we need to fundamentally lift long-term growth.
For now, the US can actually afford to pay for investments in its economy. The most important investment is human capital, such as education and training for workers, but spending for that is controlled primarily by state and local governments, not Washington.
Federal policymakers do have the power to invest in repairing and upgrading infrastructure, paid for by gradual increases in taxes. This has the potential to increase productivity growth, stimulate more private investment, gain bipartisan support and connect, instead of further divide, rural and urban Americans.
Even that may not be enough to generate the investment desperately needed in the private sector, if the uncertainty in Washington isn’t resolved. That requires a heavier political lift.
There is a major test coming up. Congress has the power to avert another government shutdown on February 15, even if a border security compromise doesn’t satisfy the president. If Congress exerts its authority, that will represent an important step in the right direction.