In January 1981, Ronald Reagan promoted Reaganomics with its basic policy of reducing taxes, reducing government expenditure, and eliminating regulations for a “Great America” as its top priority. Strangely with the same slogan, President Trump has been working hard on the economic reconstruction of the United States. The stock market that operates from a short-term perspective has a strong expectation for Mr. Trump’s large-scale tax reduction and infrastructure investment. Stock price appreciation seems to be a success of Trumponomics, but a full-fledged start is only just beginning. Will this bring an end to the big stream economic deceleration, inflation rate decline, and interest rate decline that has been going on in the US for the past 20 years?
In 2017 the economic growth rate in the US was at 2.18% (previously 1.6%) and is expected to be in the 2% range in 2018 as well. The Trump administration has launched various economic policies called Trumponomics with a commitment to raise the economic growth rate to an average of 3.5%.
Although the approval rate of the Trump administration has remained sluggish at around 40%, the economy is recovering steadily and economic policy has a relatively high support rate. The first year in office was focused on the abolition of Obama care and deregulation, with an agenda to reform the tax system for the first time in 30 years and withdraw from TPP, but (1) significant tax cuts (2) infrastructure investment (3) and protectionist trade policy are currently being implemented in full effect.
Strong support from low-income Caucasian Americans, who believe that employment has been lost as a result of globalization, causing a redistribution of wealth to residents other than Americans has been the driving force behind his campaign. By hiring American people, Trump has added 1.2 million jobs per GDP growth of 1%. Trump pledges to create 25 million jobs in 10 years as the growth rate increases by 1.5%.
President Trump has passed some of the largest tax cuts since 1986 under the Reagan administration by a close margin. Reducing the corporate tax from 35% to 21%, with a maximum tax rate for individual business owners and partnerships of 39.6% to 29.6%. The maximum tax rate on personal income tax is also lowered from 39.6% to 37%. This includes a deduction of $12,000 for single-parent households and a deduction of $ 24,000 for households where both parents are working full-time. This is the biggest tax cut in US history. On the other hand, there are parties that criticize it as being favorable to big companies and millionaires. It is expected that this tax reform will reduce revenues by 1.5 trillion dollars over the next 10 years and will add 1.4 trillion to the US deficit which is already at $ 20 trillion.
Pledging to spend a total of 200 billion dollars over the course of ten years to develop and expand infrastructure (roads, bridges, railroads, tunnels, airports, etc.) that has been pointed out as obsolete. Trump plans to promote employment by bringing incentives to private enterprises through public works.
If domestic demand is increased by dramatic tax cuts and infrastructure investment, it is possible to temporarily increase GDP, but the fiscal deficit will also expand. That will cause an increase in real interest rates. Under the floating exchange rate system with free movement of capital, investment funds will flow in from overseas into the United States with high-interest rates to convert foreign currencies into dollars in search of more favorable investment opportunities. This will cause a demand for the dollar and create dollar appreciation. As a result, the GDP will decrease as exports decrease and imports increase. Changes in the exchange rate will negate the effect of an expansionary fiscal policy.
Trump withdrew from the TPP immediately after taking office. Additionally, since US manufacturing products account for about a quarter of imports in Canada and Mexico, and the trade deficit in the United States is expanding, President Trump said NAFTA ($ 75.3 billion) and the US-Korea FTA (▲ $ 27.6 billion) need to be reconsidered as well. However, confrontation with moderate factions within the administration has deepened the gap.
Because American people import cheap goods with low tariffs from around the world, protectionist policies may not be easy on household wallets. Even if companies increase their production base in the United States and domestic production increases, on a global scale consumer will still have to buy expensive products, causing prices to rise over the medium to long-term and real income Is impaired. If you apply even higher tariffs, imports will decrease. Then the dollar will begin to appreciate. If that condition persists, a dollar-denominated debt of emerging countries will swell and currencies other than dollars will depreciate. As a result, import restrictions by tariffs create conditions that are unfavorable for both exporters and importers.
President Trump is headed in the direction of forcibly deporting illegal immigrants which are said to be over 10 million people, and is striving to tighten working visas even while that conflicts with the law. Although regulations try to increase employment and income of Americans, if the economic mechanism is complicated and the economic pie shrinks due to immigration restrictions, employment and income may also be reduced. (1) long hours of work, (2) an increase in the number of workers, (3) an increase in labor productivity will increase the GDP. Immigrants have supported the US economy with a large labor force in the United States. Immigration restrictions will cause(2) a diminish and the quality of labor force with a stop in innovation advancements. In other words (3) restrictions on immigration are said to lower the economic growth rate in the “medium to long-term” and the potential economic growth rate will be even lower.
The purpose of deregulation is to encourage new entrants, promoting competition and raising labor productivity. The President decreed that he will ease two regulations for every new regulation set. Trump also approved the long-distance oil pipeline “Keystone XL pipeline construction project.” Furthermore, by utilizing personnel authority, Trump will place deregulation on top of each ministerial and financial supervisory agency. Trump has already abolished the 15 regulations enforced by the Obama administration, including restrictions on the protection of privacy on the Internet, and is also considering abolishing the guidelines on financial supervision.
If you do deregulation and drastically reduce taxes to spread financial resources it is possible to temporarily raise the growth rate of the United States. However, the essence of the additional finance effect is only borrowing from future income and is not an improvement of the potential growth rate. Since the unemployment rate in the United States is 4.1%, (as of October 2017) considered to be full employment, the expectation of inflation rises due to the continuation of large-scale finance. There is a concern of falling into stagflation, causing low growth and high inflation.
While history does not repeat, this stagflation is similar to 1981 when President Reagan took office. Despite the recession in the US economy, inflation was progressing. The Reagan administration tried to overcome the hardships with a massive investment tax cut and monetary tightening, but the high-interest rate policy directly linked to excessive dollar appreciation. As a result, the United States embraced the “twin deficit” of a huge trade deficit and fiscal deficit.
The plaza agreement which took place in September 1985, was a call from the United States who could not endure their situation any longer. Each country determined that if the US dollar continued to deteriorate it would affect the global economy, so each country decided to lower the dollar price cooperatively to increase the exports of American products in an effort to try to save the economy.
The policy mix of active finance and monetary tightening (combination of policies) is the same for Trumponomics and Reaganomics. The same consequences of dollar appreciation and the worsening trade deficit can be assumed. What will be a problem in the future depends on the actions taken when the Trump administration wants to rewind the appreciation of the dollar.
One method is an additional fiscal policy to coat low growth. The other is international policy coordination like the Plaza agreement under the Reagan administration. The second option is hard to predict at this time, as the current idea in the international community, that “exchange levels should be entrusted to free trading in the market.” This idea has penetrated China, Japan, and the Euro area, and assume no ability to correct dollar appreciation.
Reaganomics also involved a major tax reduction, deregulation, and a fiscal stimulus. However, Reaganomics aimed for economic reconstruction by enhancing the competitiveness of companies with thorough deregulation. Trump’s policies are prioritized in the order of infrastructure investment, dramatic tax reduction, and protectionism, with an emphasis placed on the government to expand demand. Additionally, in the 1980s the US faced high inflation and monetary policy was tightly managed. In the current US, the inflation rate remains extremely calm and it is said that it will take time until inflation and wages accelerate.
The point is the exchange rate. If President Trump is able to stabilize foreign exchange by preventing dollar appreciation while implementing his own economic policy, it is difficult for export reduction and import increase to occur. Therefore, it is necessary for the US to delay monetary tightening (rate hike) in order to curb the rise in interest rates. FRB’s new chairman Jay Powell remarked that a moderate rate hike is desirable despite the slow rate of wage growth.
Since 2018 the pace of economic stimulation is shifting from deregulation to fiscal policy. Policies such as deregulation, which President Trump has actively promoted in the first year of inauguration, are means for raising productivity and raising innovation, which enhance medium to long-term growth potential. Can we draw such a growth strategy with a mere expansion of domestic employment?
Policies such as substantial tax cuts and expansion of infrastructure investment will have the effect of boosting the economy in the short term. On the other hand, if protectionism is extremely strengthened, inflation will proceed through higher costs, possibly lowering real income. If additional short-term economic growth is added there will be a further rise in interest rates due to the expansion of the budget deficit. International policy coordination will also become difficult. Trumponomics has a number of factors to lower the economic growth rate over the medium to long-term, but unless the rate hike is suppressed, any economic growth will come to a halt.