Blanchard on the Election: Recession, Expansion, and Inequality

Olivier Blanchard:

In the Light of the Elections: Recession, Expansion, and Inequality: Will the economic program of President-elect Donald Trump lead to a recession or to an expansion? ... It is obviously hard to tell..., what happens to the US economy depends mainly on the balance between macroeconomic and trade measures.

On the macroeconomic front, signs point to larger fiscal deficits, as a result of both higher infrastructure spending and corporate and personal tax cuts. ...

If deficits take place, they will lead to higher spending and higher growth for some time. And with the US economy already operating close to potential, deficits will lead to higher inflation..., potentially leading the US Federal Reserve to react by increasing interest rates faster than it intended to before the election. ...

To the extent that both growth and interest rates are higher, the dollar is likely to appreciate, leading, ironically, to larger US trade deficits, which Donald Trump the candidate indicated he wanted to fight. This leads me to trade issues and trade measures. ... Imposing tariffs on a major scale would decrease growth and make a recession more likely. ... Tariffs by themselves may indeed reduce imports, increase the demand for domestic goods, and increase output... But the "by themselves" assumption is just not right: Tariffs ... would most likely lead to a tariff war and thus decrease exports. And the decrease in imports and exports would not be a wash. ...

So, in the end, expansion or recession will depend on the balance between macroeconomic and trade measures. My own guess is the first will dominate, and growth will be sustained, at least for some time. Will it be enough to satisfy those who voted for Donald Trump, worried about their incomes and their futures? I am not so sure. Growth will indeed lift most boats. But many measures will push in the opposite direction. Lower corporate taxes, lower personal taxes on the rich, and financial deregulation will increase the share of output going to capital... The (now partial?) dismantling of Obamacare, if it is to happen, will not help the twenty or so million who benefit from it today. Tariffs on foreign goods may save some middle class jobs but will destroy others and increase the cost of living for those at the bottom end of the income distribution. Inequality may well go up, not down.

Take these remarks for what they are, an early analysis of a still unknown set of measures, all with complex effects. ... But predictions of recession were too pessimistic. If macro measures dominate trade measures, we may be in for a Trump expansion, at least for a time.