As others have pointed out, orthodox Republican economic policies are now a thing of the past, although it’s far from clear what will replace it.
The recent Republican tax cuts, combined with yesterday’s deal to avert another government shutdown, will increase fiscal deficits significantly, providing a fiscal stimulus when none is needed (although much of the additional domestic spending is on important programs.) Perhaps the clearest way to see what is happening is to look at the US cyclically-adjusted general government deficit. This measure covers all levels of government and strips out the impact of growth on the deficit. (So, for example, a large fiscal deficit during a deep recession, such as in 2008-10 would look better in a cyclically-adjusted sense.) By this measure, the deficit averaged 8 1/2 percent of GDP during the post-crisis years of 2009-11 (IMF Fiscal Monitor) before declining steadily, reaching 3 1/2 percent of GDP in 2015. Now, the same measure of the fiscal deficit looks to be around 6 1/2 percent over the next two years (based on some admittedly rough calculations). This is the same level as in 2012, when economic growth was still well below trend and unemployment was roughly double the current rate. An obvious question for Republicans is why this deficit level was grounds for hand-wringing during the depths of the recession but is fine now. (I still recall candidate McCain calling for a balanced budget in the midst of the global financial crisis in 2008.)
Significantly higher deficits may mean at least temporarily higher growth but will have other important effects as well. Interest rates will likely rise faster than they would have. And the dollar should strengthen. Higher fiscal deficits will require more financing, a large part of which will come from abroad, notably from China and Japan. And trade deficits are almost sure to rise as well.
In this context, There are a number of interesting policy issues ahead, including:
- Where does the much larger structural deficit leave the idea of a large-scale program to improve US infrastructure? Probably in a big pothole somewhere.
- When will Paul Ryan “discover” the new larger deficits and renew efforts to cut Medicaid, Medicare and other social spending?
- What will Trump do when he sees the US trade deficit, and key bilateral deficits, inevitably rising? Are we more likely to see a true global trade war? Or will he simply attack the messenger and declare “fake news”?
A faster pace of rate hikes in the US and a stronger dollar will also have an impact, naturally, on the rest of the world. Perhaps most notably, these developments can substantially increase the debt burden for emerging market governments and corporates with, in a worst case scenario, implications for global financial markets.