President Trump’s continued calls for a massive tax cut and infrastructure spending package couldn’t come at a worse moment in the business cycle. And congressional Republicans’ willingness to entertain it is even more confounding.
Only six years ago, congressional Republicans risked default to avoid new government spending. With the country still reeling from the 2008 financial crisis and unemployment at 9 percent, this brinkmanship resulted in the last-minute passage of the Budget Control Act of 2011, which raised the debt limit but only in exchange for significant austerity. Republicans primarily argued that the United States, having run up large deficits in the post-crisis years, was on a similar trajectory to Greece and therefore needed to cut spending to avoid a sovereign debt crisis. Additionally, some conservative economists felt that sizable deficits, combined with the Federal Reserve’s large-scale asset purchase program (a.k.a. quantitative easing), would debase the dollar and lead to an outbreak of inflation.
The real-world outcome of the austerity was quite different. Because, unlike Greece, the United States borrows in its own sovereign currency, the first analogy was never credible. And because, at the time, there was enormous excess capacity in the economy, near-term inflation fears were overblown. Within days, the GOP’s risk-taking cost the United States its prestigious AAA bond rating, and in the following weeks the market’s verdict was made painfully clear: Stocks and bond yields tumbled in tandem, as the expected adverse growth effects of the deal, amplified by uncertainty surrounding the downgrade, reverberated through the economy.
In 2011, rather than austerity, the economy still was ripe for more stimulus. In other words, the type of plan Trump is talking about now made sense six years ago. But today – with unemployment at 4.5 percent, inflation picking up and the United States’ ratio of debt to gross domestic product higher than it has been in more than 65 years – such a plan is foolish. And stunningly, these same congressional Republicans now seem open to Trump’s road map and ready to consider an even larger infrastructure program than the one they denied President Barack Obama, in combination with an irresponsible round of deficit-increasing tax cuts.
This could all be chalked up to politics – the desire to deny Obama a victory at all costs – rather than genuine concerns about debt sustainability and runaway inflation. But the Trump package is wrong for where we are in the business cycle and could eventually hurt the economy.
Already, the bond market’s reaction to the Trump plan has been swift, with long-term interest rates soaring about 40 basis points since the election on fears that fiscal expansion, undertaken in the current economic environment, may indeed result in inflation. Republicans in thrall to Trump should take note.
Given that the Federal Reserve is in the process of slowly raising short-term interest rates, and that the ratio of total debt held by the public to GDP stands at an elevated 77 percent , today’s economy is ready for a prescription of mild austerity rather than a double dose of stimulative tax cuts and infrastructure spending. A gently contractionary fiscal policy would ease the economy just enough to prevent inflation from accelerating, while enabling the Fed to keep rates low and allowing the debt-to-GDP ratio to steadily fall to more manageable levels.
While there are undoubtedly infrastructure projects worth pursuing – in particular those with a measurable positive net return on investment – there is no rush to fund them with borrowed money today. And while tax reform is sorely needed, it should be done in a base-broadening, revenue-neutral fashion.
No matter how badly members of Congress may want to simultaneously cut taxes and increase spending, they should push back against Trump’s proposals and advocate fiscal responsibility, at least until the next downturn begins. And Republicans should demonstrate that they favor fiscal restraint not solely when the Democrats occupy the White House, but rather when the economy is at or near full employment, no matter which party the president represents.