Why the US economy has been too exciting
NOT MANY people say their goal in life is to be boring. But that’s the case for John Williams, the president of the Federal Reserve Bank of San Francisco, who is charged with overseeing the financial health of everything West of the Rockies.
Things in the economy have been far too exciting in the last decade, says Williams. And while he says the economy is generally on a strong track today, there are areas he’s watching closely – including the effect of government policies proposed by the Trump administration.
While many have emphasised the potential boost to growth from tax cuts and other measures the administration has discussed, Williams says other measures could pose a potential risk to growth, like trade restrictions or cuts to Medicaid.
This interview has been edited for length and clarity. Q. President Donald Trump’s budget proposal released last week proposed pretty dramatic cuts to programmes that help the poor, including Medicaid. What would that mean for the US economy? A. First, I don’t know what will happen in fiscal policy. There are a lot of proposals, but what really matters is what Congress enacts and the president signs. Second, some of these proposals would boost growth in the short runlike more spending on defense. But other changes that have been talked about, including trade restrictions, would have a negative effect in the short run.
Significant cuts in Medicaid or other programmes affect money in people’s pockets that gets spent pretty much dollar for dollar. So cutbacks in spending that go to lower-income people have the biggest effect on the short-run of the economy. It’s different for tax cuts, especially for wealthier people, because a lot of that money is saved rather than spent. It doesn’t make it right or wrong, I’m just saying in the short run that doesn’t boost the economy as much.
A lot of people were expecting that tax cuts and less regulation would boost the economy, but if you match it with spending cuts, in the short run the effect could actually be negative. It depends on how the mix works. And that’s why it matters what happens, not just what people are talking about.
In my view the economy is in a good place and we really shouldn’t be focused on boosting it in the short run. We should be focused on long run growth and prosperity. That means promoting investments in research, the sciences and education. What worries me is that we are underinvesting in a lot of these areas. Q. One of the main measures the administration has talked about to boost growth is cutting the corporate tax rate and encouraging companies to repatriate more earnings. Would that increase investment? A. I do believe our corporate tax system is far out of date. This whole repatriation issue is because our corporate tax system is not well designed for the modern world.
But one should be suitably humble that this should have a huge effect on investment. Research has shown that just lowering the tax rates or having a repatriation holiday is probably not going to have a big effect.
Most businesses are not paying that very high rate, and there are a lot of things that go into corporate investment decisions besides taxes. Companies are sitting on a lot of cash, so they’ve already chosen how much investment to do. We know from the past that if you allow companies to repatriate profits at a very low tax rate, they’re likely to hand it out in dividends and stock repurchases. There’s nothing wrong with that, but it doesn’t change incentives for businesses to invest in a new building or factory, for example. Q. The budget assumes growth of three per cent, something others have criticised and that the administration has vigorously defended. Is that kind of growth achievable? A. It is twice as high as my estimate of trend growth, which is 1.5 per cent.
If you go back to history, you can look at when we had three per cent GDP growth over an extended period of time. One period was the 1980s, when a surge of people were entering the labour force, the Baby Boomer generation and women. That pushed the potential growth rate of the economy up. I don’t think we’re going to repeat that.
Then there were two periods when we had productivity surges that allowed the economy to grow three per cent. One was the post-war period up to the early 70s.
The second was 1995 to 2004, where we had a huge tech boom and the growth of the internet. Our best research shows that there is not another surge of productivity on the horizon, and labour force growth is slower, so it’s hard to see how you’re going to get really rapid growth for a 10-year period. — WP-Bloomberg