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2016-12-13 19:22:17
A Trump Economic Boom? The Fed May Stand in the Way

WASHINGTON — Investors in financial markets, and those predicting faster economic growth in 2017, would do well to remember the famous words that William McChesney Martin Jr., the former Federal Reserve chairman, uttered way back in 1955: The Fed’s job is to remove the punch bowl just as the party gets going.

President-elect Donald J. Trump’s promises to cut taxes and regulation and to increase spending on infrastructure and defense have convinced many that a sugar high in the near term will goose the economy. But Fed officials say the economy is already expanding at something close to its maximum sustainable pace, meaning faster growth would drive inflation toward unwelcome levels.

To avoid overheating, the Fed could respond by raising interest rates more quickly. The more Mr. Trump stimulates growth, the faster the Fed is likely to increase rates.

“I guess I would argue that I think people have gotten a bit ahead of themselves about what a Trump presidency would mean,” said Lewis Alexander, chief United States economist at Nomura. “If we have a big stimulus, the logical thing for the Fed to do is to raise rates faster. There isn’t a whole heck of a lot of scope to just let the economy run under those circumstances. There’s a big question about whether fiscal stimulus under Trump just leads to higher interest rates.”

Underscoring that question, the Fed is expected to raise its benchmark rate on Wednesday for the first time since last December in light of new economic data. The rate sits in a range of 0.25 percent to 0.5 percent, a low level intended to stimulate economic growth by encouraging borrowing and risk-taking. Analysts predict the Fed will shift the range upward by a quarter of a percentage point, modestly reducing those incentives.

The rate increase is widely regarded as a foregone conclusion. The odds, derived from asset prices, topped 95 percent Monday, according to the CME Group. The looming question is how quickly the Fed will continue to raise rates in 2017.

Economic forecasts always require large assumptions, but that is particularly true in the present case because Mr. Trump has provided relatively few details about his plans. Perhaps the most accurate thing that can be said about Mr. Trump’s victory is that it has increased the uncertainty of the economic outlook.

“At this juncture, it is premature to reach firm conclusions about what will likely occur,” William C. Dudley, president of the New York Fed, said in a recent speech.

During his campaign, Mr. Trump predicted 4 percent annual growth, and his actions since Election Day point to a single-minded goal of short-term job creation.

“Our No. 1 priority is going to be the economy, get back to 3 to 4 percent growth,” Steven Mnuchin, Mr. Trump’s pick to serve as Treasury secretary, said last month.

Many economists regard such growth predictions as fanciful; the economy has been mired in an extended period of slow growth and the reasons, including an aging population and a dearth of innovation, are unlikely to change quickly. Some think Mr. Trump is more likely to push the economy into recession than to catalyze a new boom.

Even if Mr. Trump is right, however, the Fed does not want 4 percent growth.

The central bank’s outlook has become increasingly gloomy. Officials estimated in September that annual growth of 1.8 percent was the maximum sustainable pace, and they predicted growth would not exceed 2 percent in the next three years. They will update those forecasts Wednesday, but large shifts are unlikely.

Fed officials also are increasingly convinced that steady job growth has substantially eliminated the post-recession backlog of people seeking work. The unemployment rate fell to 4.6 percent in November, a level the Fed regards as healthy.

For years, Fed officials urged Congress to increase fiscal spending. Now, Mr. Trump is promising to do just that — and the Fed has concluded that it is too late.

Stanley Fischer, the Fed’s vice chairman, said last month the Fed might still benefit from fiscal stimulus because it could raise rates more quickly. That would increase the Fed’s ability to respond to future downturns by reducing interest rates.

But such gains would come at real cost: A fiscal stimulus would increase the federal government’s debt burden, which already is at a high level by historical standards, reducing the room for a fiscal response to a future downturn. Janet L. Yellen, the Fed’s chairwoman, urged Congress last month to be mindful that the government is already on the hook for more spending as baby boomers age into retirement.

“With the debt-to-G.D.P. ratio at around 77 percent, there’s not a lot of fiscal space, should a shock to the economy occur, an adverse shock, that did require fiscal stimulus,” she said.

The tension between fiscal and monetary policy is likely to unfold in slow motion.

Mr. Trump has promised to press for rapid changes in government policy, but Congress is not built for speed. A similar effort to cut taxes at the beginning of the George W. Bush administration, for example, was signed into law on June 7, 2001. The impact of new cuts, and any increase in infrastructure spending that Mr. Trump can persuade dubious Republicans to embrace, would be felt mostly in future years.

Mark M. Zandi, chief economist at Moody’s Analytics, predicted that tax cuts, regulatory rollbacks and deficit-financed spending would fuel faster growth in the first half of Mr. Trump’s four-year term. But he said that the Fed’s rate increases, and restrictions on trade and immigration, would gradually begin to take a larger toll. By the end, Mr. Zandi predicted, the American economy would be “unnervingly close” to recession.

“The Fed and markets in general will ultimately wash out any benefit,” Mr. Zandi said Monday. “The economy under President Trump ultimately will be diminished.”

Other economists are more optimistic, predicting that the stimulus will not be fully offset by Fed policy. Mr. Dudley appeared to endorse this view in his recent speech, suggesting that the rise in financial markets was “broadly appropriate.”

Some of Mr. Trump’s proposals also could increase the economy’s potential growth rate, for example by improving infrastructure or encouraging corporate investment.

On the other hand, the Fed’s march toward higher rates may be amplified by the bond market. Rates are already rising, and investors concerned about inflation and larger federal deficits are likely to generate persistent upward pressure.

Those effects are already visible. Stock prices have climbed since Mr. Trump’s surprising victory, increasing the wealth of shareholders. But borrowing costs also climbed. The average rate on a 30-year mortgage loan was 4.13 percent last week, according to Freddie Mac, up from 3.54 percent just before the election.