Blanchard on Trumponomics

How will Trumponomics work out? This is a question that many people are asking, including Olivier Blanchard (see here). Blanchard focusses on three broad policy characteristics of Trumponomics: tariffs, tax cuts, and mass deportations of illegal immigrants. His analysis is based on "textbook macroeconomic principles." His conclusion is that the president-elect will be disappointed with the results, but that the outcome will not be the catastrophe that many are predicting. This may very well be the case. But the purpose of this piece is not to question Blanchard's prediction. What I want to do instead is evaluate the reasoning he applies to each policy (a reasoning based on "textbook macroeconomic principles."

Tariffs.

Blanchard predicts that a broad-based tariff policy (if enacted) will cause a decline in U.S. imports and an increase in tariff revenue; at least, in the short run. U.S. demand will shift from foreign to domestic goods and services. Since the U.S. economy is close to full employment, the increase in demand for domestically produced goods and services will manifest itself as inflation. This inflationary burst will likely lead the Fed to raise its policy rate. Higher interest rates will strengthen the U.S. dollar, discouraging U.S. exports. Retatiatory tariffs would reduce the foreign demand for U.S. exports even more. Summary: higher interest rates, higher inflation, little change in the trade deficit, unhappy exporters.

This seems plausible. A broad-based tariff is likely to increase the cost-of-living; at least, in the short run. The rate of change in the cost-of-living (the inflation rate), however, is likely only to jump up temporarily; see, for example, how increases in the Japanese VAT correlate with inflation:

Would the Fed necessarily raise its policy rate against a temporary burst of inflation that was not demand-driven? A case could be made that it should not. Given the recent experience, however, it wouldn't be unreasonable to expect policy to tighten. Blanchard believes that this will cause the USD to appreciate, discouraging U.S. exports. But why wouldn't these discouraged exporters then not try to redirect their sales to the domestic market? If they did, this should put downward pressure on domestically produced goods and services, and downward pressure on inflation. Of course, all sorts of things may happen instead. For example, reduced profit margins may lead to layoffs. I'm not sure how many of these effects Blanchard's simple model takes into account.

Immigration

It is estimated that there are approximately 10M illegal immigrants in the U.S., representing about 5% of the workforce. Blanchard believes that deporting immigrants (say, 1M/year) will lead to an increase in the vacancy-to-unemployment ratio (a measure of the tightness of the labor market) which will, in turn, lead to persistently higher inflationary pressure, leading the Fed to raise its policy rate. Again, higher inflation and interest rates is not what the new administration is looking for.

However distasteful one finds the concept of mass deportations, this is not a new phenomenon in the U.S.; see (source):

What is remarkable about the fact above is how almost nobody talks about it. Why the sudden concern on how the policy might affect inflation and interest rates? Blanchard believes that inflationary pressure and employer resentment will mean the deportations will not happen on a mass scale. While this may turn out to be the case, the rationale Blanchard bases his conclusion is not supported in the data.

Tax cuts

I've expressed concerns over the projected path of fiscal policy for a while now; see here. I've also written on how I believe we've switched from a deflationary-pressure regime to an inflationary-pressure regime; see here. I do not, however, see these concerns as being specific to Trumponomics--a new Harris-Walz administration would not likely have had much an effect on the tectonic forces determining these regimes.

One factor I've not emphasized in my discussions is the prospect of a sustained boom in U.S. productivity. Roger Farmer suggests (see here) that regulatory reforms in the oil and gas sector may indeed unleash a productivity boom. The resulting boom in economic activity would make the growing supply of U.S. Treasury securities more "sustainable" (in the sense that USTs would be more willingly held at lower yields and lower rates of inflation). It is interesting to note that "r less than g" continues to be a property of the U.S. economy, though barely:

I suppose the question boils down to "Whither r v g?"