Obama Delivers Sturdy Economy to Incoming Trump Team

David J. Stockton says the US economic outlook is strong and full employment is close at hand, which should allow the Fed to gradually raise interest rates—although President-elect Trump introduces new uncertainties.

Unedited transcript

Pedro Da Costa: I’m Pedro Da Costa and this is Peterson Perspectives. I’m joined by David Stockton. He’s a senior fellow here at the institute and a former chief economist at the Fed and I’m hoping he’s going to help me decipher the outlook for the U.S. economy as President Obama prepares to hand the reins over to President-Elect Trump.

Now, the U.S. economy has been fairly steady recently. The data has pointed to fairly steady GDP growth of around 2%. Payroll employment has been steady. It’s hard to see this as a vote that was a rejection of the Obama economy. How do you think we are going into 2017?

David Stockton: So I think the economy that President Obama’s handing over to President-Elect Trump is just about as good as the economy has been since any time before the financial crisis. And maybe even a little better in the sense that we don’t really see the imbalances that were building before the financial crisis in the current economy. So, it has sustained growth, as you noted, of 2% over recent years. And in fact, I think that’s probably how we’re heading into 2017 with a similar pace.

So more recently, if anything, growth’s been a little better. But it’s fundamentally, a reasonably balanced, healthy economy that is nearing full employment. We don’t know exactly where that is, but we’re probably pretty close at this point.

Pedro Da Costa: Yeah. Well, the unemployment rate was 4.6% at that latest brush. And so one of the reasons that I guess people didn’t feel that this recovery was really a recovery or that they were benefiting from it, is the lack of wage growth that’s really been persistent really even from before the great recession. How is that looking? And how do you think policy makers at the Fed are going to look at that trend in it and how it might inform their thinking.

David Stockton: So in fact, I think we’re seeing some signs that wages over the past year had firmed, but not a lot, that we sort of moved up from the 2% range that we’d been running in for a number of years. We’re probably running at around 2.5% right now.

Unfortunately, I mean one of the reasons I think why people had felt this recovery has been disappointing is that the growth and productivity to support those wage increases has been weak as well. So there isn’t a lot of upside potential at this point.

And I think the Fed is going to be encouraged in the following sense that they were worried that inflation, just a year ago or so, was running 1.25% or sort running 1.75% and appeared to be headed back to their 2% objective. So they’re going to feel a little more confident about that. I think they’re going be looking at economy close to full employment, growing it close to potential. I think all of that sets them up for raising interest rates in December for the second time in a year.

Pedro Da Costa: Really, really gradual pace.

David Stockton: Really, really gradual pace.

Pedro Da Costa: So given that that December rate hike is sort of baked into the cake now, what kind of economic policy do you expect from President-Elect Trump and what does that lead the Fed? I mean the market’s had initially been focusing on the potential for physical stimulus and for deregulation. What can we expect?

David Stockton: So in fact, I think we’ll get those things. I think they will take longer and the process will be a little bit uglier than seems to be the market’s current expectation. I think 2017 will be a year in which there will be a lot of negotiation. It will like something’s going to pass. Then it will look like it’s going to fail, then it will look like it’s going to pass.

In the end, I think, they will pass tax cuts and some increase in infrastructure spending, not of the scale that President-Elect Trump has proposed and I don’t think even of the scale that Representative Ryan has suggested. There will be enough pushback from the remaining moderate republic. There’s some deficit haws that remain in the republican side to prevent quite as a big a blowout on the deficit side as the Trump or Ryan plans would likely produce.

Pedro Da Costa: Okay. And does that leave Fed policy in a sort of pleasantly boring place where they can afford to wait and see and actually raise rates at a gradual pace that the economy remains in?

David Stockton: So I think, over the longer term or the medium term, we’re looking probably at faster pace of rates because we are going to have more physical stimulus in an economy that is already approaching full employment with inflation pushing up some.

But for 2017, in fact, I don’t think we’re going to see a significantly different contour to Fed policy that we were previously expecting. The Fed is not going to raised rates in anticipation of physical policy that has not yet been enacted. And even when it’s enacted, there’s going to be some about what effect that policy is going to have on the economy.

The tax plans that are currently being considered or most likely to be considered are ones that are tilted heavily towards delivering tax cuts to very wealthy individuals. Those individuals have relatively small marginal propensities to consume so this pending impetus coming about from those tax cuts could be relatively limited.

So I think the Fed is going to be, like you say, in a comfortable position to wait and see. I think they’re going to follow the data. If the data continue to look strong, if the unemployment rate continues to drop, the inflation rate continues to rise, we might see faster pace than the two increases that the Fed is currently anticipating. But I don’t think it’s going to be a dramatic or immediate change in the contour of monetary policy.

Pedro Da Costa: Okay. And then finally, as far as the uncertainty factor, here you have a president-elect. Normally, you have presidents who studiously avoid making market and moving comments in any way shape, or form.

And now, you have a president-elect, who’s very willing to go there whether it’s on trade policy to whether it’s on China-Taiwan policy, how does that affect financial markets and planning for the future and the kind of the business backdrop.

David Stockton: So, so far, until the last couple of days, I think it affected in the following way, it’s made businesses and market participants more optimistic about the outcome. They’re looking at that possibility of significant tax cuts, corporate tax cuts, and significant moves towards less regulation. In the last couple of days, we’ve seen what could be the beginning of the downside and a greater uncertainty and maybe a shift to some pessimism, certainly in some sectors of the economy.

As President Trump has indicated, he’s going to be more serious about the possibility of imposing trade restrictions and tariffs that can do some serious damage, as our colleague, Mark [inaudible 00:06:20.1] here at the institute with few other colleagues had showed earlier this fall. The potential for significant trade war would really have very devastating consequences for the U.S. economy.

We simply don’t know where President-Elect Trump is going to come out when he actually starts making policy. How much of this is just threat. But how much of it could in fact be put into action. And at least for a time in some sectors, that uncertainty could very well weigh on investment activity and hiring.

Pedro Da Costa: Okay. David Stockton, thank you so much.

David Stockton: Thank you, Pedro.