The big event of November was, of course, the election of Donald Trump in the United States. The first thing to keep in mind is the uncertainty surrounding his plans, especially his economic programme. Second, there can be a wide gap between what a candidate says and what he does, once in office. That said, Trump’s statements do provide us with a general outline of at least three complementary scenarios.
The first of these, which is currently our baseline scenario, is the “perfect son-in-law” scenario. The positive demand-side effects will offset the negative fallout of supply-side measures, and US growth will reaccelerate on a sustained basis. This will require an improvement in the ratio of productive investment to productivity gains, which could very well happen if the environment created turns out to be particularly business-friendly. Remember that the economy that Trump is inheriting is not in bad shape. Under this scenario, the new administration would focus on domestic concerns and not on tightening up protectionism against the rest of the world and the Chinese in particular.
The second scenario, which we call the “awkward customer” scenario, and to which we assign a low probability, suggests that growth will disappoint once again, i.e., that the current upturn will last just two or three quarters. For, while the economy is improving, potential growth remains low at about 1.5%, and immigration announcements are not going to help matters. If households decided to save more than they currently do – for example, because real-estate prices have returned to their July 2006 levels, or because their long-term prospects and retirement plans require them to do so – growth could very well slow drastically and hold back any prospect of a rebound in investment. A new slowdown in growth could be exacerbated by the non-domestic sector, driven by trade and geopolitical tensions in particular.
The third, “endless love” scenario, which is also not our baseline scenario but is more likely than the second scenario, is similar to the first. But it assumes that inflation will exceed expectations. At current levels of employment, wages could very well accelerate (the latest, November figures do not suggest this), bringing out a “tough” version of Trump’s protectionist measures; domestic demand could add a few dozen basis points to inflation; and heavier deficits could boost growth through an increase in nominal rates.
That leaves the Fed. In the short term, i.e., under Yellen’s watch, which ends in February 2018, there appears to be little risk of “major errors” in managing monetary policy or guidance. Unless, of course, the first scenario is not the one, in which case, the Fed would have simply been mistaken in its analysis. However, the new Fed chairman is likely to be less politically independent.
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