Jan. 12, 2021
For all the problems that President Donald Trump’s disdain of elite expertise has caused over the past four years, his willingness to ignore economic orthodoxy in one crucial area has been vindicated, offering a lesson for the Biden years and beyond.
During Trump’s time in office, it has become clear that the U.S. economy can surpass what technocrats once thought were its limits: Specifically, the jobless rate can fall lower and government budget deficits can run higher than was once widely believed without setting off an inflationary spiral.
Some leading liberal economists warned that Trump’s deficit-financed tax cuts would create a mere “sugar high” of a short-lived boost to growth. The Congressional Budget Office forecast that economic benefits of the president’s signature tax law would be partly offset by higher interest rates that would discourage private investment.
And the Federal Reserve in 2017 and 2018 took action to prevent the economy from getting too hot — driven by models suggesting that an improving labor market would eventually cause excessive inflation.
These warnings did not come true.
Before the pandemic took hold, the jobless rate was below 4%, inflation was low and wages were rising at a steady clip, especially for low and middle earners. The inflation-adjusted income of the median U.S. household rose 9% from 2016 to 2019.
The higher interest rates from unfunded tax cuts that had been forecast did not materialize; the CBO in spring 2018 had expected the 10-year Treasury bond yield to average 3.5% in 2019. In fact, it averaged a mere 2.1%, making federal borrowing more manageable.
And the Fed cut interest rates starting in 2019 despite a very low jobless rate, implicitly accepting the premise that it had moved too aggressively with rate increases to prevent inflation that never arrived.
Trump has sent plenty of mixed signals on both deficits and interest rate policies over the years. He has intermittently promised to eliminate the national debt, even as his policies expanded it; he supported rate increases in 2015, accusing the Fed of keeping them low to help President Barack Obama; and some of his Federal Reserve appointees were monetary hawks (though not those who managed to win Senate confirmation).
But the experience of his presidency — particularly the buoyant economy before the pandemic began — shows what is possible. It may not have been the best economy ever, as he has repeatedly claimed, but it was easily the strongest since the late 1990s, and before that you have to go back to the late 1960s to find similar conditions.
If Trump was able to ignore economic orthodoxy and achieve the best economic outcomes in years, it’s worth asking how much value that orthodoxy held to begin with.
Just maybe, does the success of Trumponomics tell us that we’ve been doing something wrong for decades?
The Not-So-Great Moderation
To understand how deeply entrenched the centrist conventional wisdom around economic policy has been over the past generation, consider a curious incident from August 1994. Alan Blinder, the newly named vice chairman of the Federal Reserve, gave a speech at an annual symposium of central bankers in Jackson Hole, Wyoming, in which he described trying to reduce unemployment as an important role for the Fed.
Some huffing and puffing ensued. There was talk in the hallways about Blinder’s focus on unemployment rather than on inflation prevention, which central bankers viewed as their main goal. It made its way into the news media, including some scathing attacks.
“Put simply, Blinder is ‘soft’ on inflation,” Newsweek columnist Robert J. Samuelson wrote. Without adequate anti-inflation conviction, “Blinder lacks the moral or intellectual qualities needed to lead the Fed.”
“I was pilloried for suggesting that we might get below 6% on the unemployment rate,” Blinder, a Princeton economist, said recently.
A widespread view among economic policy elites, after the runaway inflation in the 1970s and early 1980s, was that elevated unemployment was a necessary cost of keeping prices stable. Also, that the government can’t spend much more money than it takes in without crowding out private investment — leaving the economy weaker over time — and that policymakers should act preemptively to ward off these risks.
That intellectual consensus lurked beneath many momentous decisions. Among them: the deficit-reduction agenda of the Bill Clinton administration; the interest rate increases of the Alan Greenspan Fed during George W. Bush’s second term; and the Obama administration’s determination not to increase the deficit in devising its signature health care law.
This view was shaped by a reliance on the “Phillips curve,” which describes the relationship between the jobless rate and inflation. As applied by a generation of central bankers, it was treated as a useful guide to setting policy. If the unemployment rate went too low, the logic went, inflation was inevitable, so central bankers needed to prevent that from happening.
When Fed leaders raised interest rates in December 2015, for example, their consensus view was that the long-run unemployment rate — the goal they were ultimately seeking — was 4.9%.
If the job market kept improving, then-Fed Chair Janet Yellen said at the meeting where that interest rate increase was decided, “we would want to check the pace of employment growth somewhat to reduce the risk of overheating.”
Yet from spring of 2018 to the onset of the pandemic, the United States experienced a jobless rate of 4% or lower, with no obvious sign of inflation and many signs that less advantaged workers were able to find work. Reality turned out better than the 2015 officials thought possible.
Since the 1980s, recessions have been rarer than they were in the immediate post-World War II era, but they have been followed by long, “jobless” recoveries. Much of that time has featured weak growth in workers’ wages.
It turns out that when you try to choke off the economy whenever it is starting to get hot, U.S. workers suffer. The Fed has been like a driver who aspires to cruise at the speed limit but starts tapping the brakes whenever the car gets anywhere close to that limit — and therefore rarely attains it.
From 1948 to 1969, the unemployment rate was at or below 4%, 39% of the time. Since 1980, that has been the case less than 8% of the time.
Economists have referred to the period from the early 1980s through the 2008 financial crisis as “the great moderation,” because recessions were rare and mild. But with more years of hindsight, that period looks less like a success.
“There’s nothing particularly moderate or particularly great about the great moderation,” said Larry Summers, the Harvard economist and former Treasury secretary.
In effect, the last four years at the Fed have made clear both how much things have changed and how much they needed to. Yellen (now President-elect Joe Biden’s Treasury secretary nominee) started the first of a series of interest rate increases in late 2015, and the current chair, Jerome Powell, continued them.
But the logic kept breaking down. Inflation kept coming in below the 2% target the central bank aims for, even as the jobless rate kept falling. It’s not terribly clear what was necessary about the rate increases, as Trump’s harangues against Powell expressed vividly. Arguably, they reflected a reliance on old economic models and the same inflation-fighting muscle memory that caused the backlash against Blinder a quarter-century earlier.
Trump violated decades of precedent under which presidents don’t jawbone the Fed, which seeks to maintain political independence. But that didn’t make him wrong about interest rates.
Macro or Micro?
On March 18, 2019, a group of Trump’s economic advisers gathered in the Oval Office to show him the annual “Economic Report of the President,” a 700-page document that amounts to an official statement of the administration’s economic achievements, analysis and goals.
He was particularly excited about one page of charts, said Casey Mulligan, one of the advisers. They showed that the economy had created far more jobs and had a much lower jobless rate than the CBO had projected just before the 2016 election. The president called in Dan Scavino, his social media director, and fired off a tweet about the results.
A central question for Biden will be: To what degree is the Trump-era economic success a result of policies that liberals disagree with, to what degree is it a result of policies that Biden might embrace, and to what degree is it just luck?
Mulligan and other allies of the president emphasize the role of deregulating major industries and lowering taxes on business investment — microeconomic strategies — as crucial to the economy’s success.
“The forecasts systematically overpredicted the Obama economy every year, and throughout the Trump administration, they underpredicted,” said Mulligan, an economics professor at the University of Chicago. “What nobody in the intelligentsia was paying attention to was the regulations that were holding us back.”
The Biden administration and Democratic Congress will view more aggressive regulation as a core goal, aimed at preventing corporate misbehavior, protecting the environment and more. Indeed, left-leaning economists would argue that the very policies Mulligan credits with the boom are the least durable parts of the Trump-era expansion.
“It is true that the corporate giveaway aspect of the policies, cutting taxes and scaling back regulation and so forth, coincided with an unequal prosperity that lasted longer prior to COVID than I would have guessed it would,” said Summers, a prominent proponent of the “sugar high” theory of the Trump economy. “But I don’t think it had any particularly strong foundation in terms of increasing productivity or capital investment.”
If you believe Mulligan and other Trump allies, the macroeconomic lessons of the Trump years — those having to do with things like deficits, inflation and interest rates — won’t be enough for the Biden administration to re-create the 2019 economy. In this view, the microeconomic details of how the president has governed will be crucial, and the policies that Biden has advocated — in areas as varied as tighter restrictions on carbon emissions and more aggressive regulation of banks — will prove counterproductive to the cause.
Lessons for the Next Administration
The people who will shape economic policy in the new administration seem eager to push for a post-pandemic economic surge reflecting the (macroeconomic) lessons of the last four years.
Yellen has a background as a labor economist, and in the 1990s, as a Fed official, she urged Greenspan to raise rates preemptively based on the inflation risks that the Phillips curve predicted. At that fateful meeting to increase rates in 2015, she raised an intriguing possibility. If inflation were to remain persistently low, she said, “a more radical rethinking of the economy’s productive potential would surely be in order.”
That radical rethinking is now very much underway — including by Yellen.
“Allowing the labor market to run hot could bring substantial benefits,” Yellen said in a speech at the Brookings Institution in 2019. She said that a high-pressure economy — one in which unemployment is low and employers have to compete for workers — improves upward mobility. She added: “We’re seeing that in the current expansion. Those who are least advantaged in the labor market — those with less education and minorities — are experiencing the largest gains in wages and declines in unemployment.”
Powell, who will lead the Fed for roughly the first year of Biden’s term and then will be either reappointed or replaced in February 2022, has also become a vocal enthusiast for avoiding these mistakes of the past.
In the strong pre-pandemic labor market, he said in an August speech on the Fed’s new policy framework, “many who had been left behind for too long were finding jobs, benefiting their families and communities, and increasing the productive capacity of our economy.”
“It is hard to overstate the benefits of sustaining a strong labor market,” he said, and the central bank’s new policy language “reflects our view that a robust job market can be sustained without causing an outbreak of inflation.”
In recent years, the CBO, which plays a crucial role forecasting the fiscal and economic effects of different policies, has reexamined its view of future interest rates in ways that have lowered the projected cost of public debt.
In early 2017 when Trump took office, for example, the CBO projected that by 2020 the government would need to pay at a 3.2% rate to borrow money for a decade. The actual rate is now just over 1%, even after a surge over the past week. While that reflects the pandemic-induced downturn, even at the start of 2020 the rate was 2%. The CBO’s most recent forecast is that it will remain below 3% through 2029.
Biden has embraced these lessons in shaping his agenda, as he made clear in a news conference Friday where he confirmed that his plans will add up to trillions of dollars when one includes both pandemic response money and longer-term plans.
“With interest rates as low as they are,” Biden said, “every major economist thinks we should be investing in deficit spending to generate economic growth.”
One of the big plot twists of this era is that Biden’s plan to make the U.S. economy great again seems to rest on applying the macroeconomic lessons of the Trump era.
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