Economic Growth and the Looming Threat of Inflation

For the past decade, the Federal Reserve has maintained historically low interest rates. A great deal of the economic growth that the United States has experienced can be attributed to this. The phenomenon of the “boom and bust” cycle is nothing new to the US, with an abundance of alternating phases of economic growth and decline. Historically, “booms” have come from geo-political events like World War II, or domestic policy enactments such as the Employment Act of 1946 under the Truman Administration or the Stimulus Spending Bill under the Kennedy Administration. All of these examples helped to propel the United States away from times of sluggish growth. “Busts” have often resulted from similar but converse events. Industrial growth during World War II dwindled following post-war demobilization, and wage-price controls such as those adopted under the Nixon Administration put a damper on improving employment rates.  Above all else however, busts can be attributed to the Federal Reserve raising interest rates. Following the 2008 financial crisis, the interest rate cycle was halted and the American Recovery and Reinvestment Act, instituted by the Obama Administration, has since allowed interest rates to hover around zero percent. After close to ten years of economic expansion and growth, and with the national unemployment at 4.1%, inflationary rhetoric is back to being front and center on Capitol Hill. This partially explains the recent volatility in the stock market. Much of the anxiety revolves around household consumption and the rise in prices of goods and services, apart from food and gasoline. As it becomes evident that the prolonged period of exceedingly low inflation could be coming to an end, the role of the Federal Reserve becomes once again important for a restoration of confidence in the economy. With imminent interest rate hikes on the horizon, the looming threat of inflation is set to impact not only the success of President Trump’s Stimulus package, but more importantly the trajectory of the economy as a whole.

Historical Context: The Swinging Pendulum of Booms and Busts

Bill Clinton (1993-2001)

Moral impairments and subsequent impeachment aside, Bill Clinton’s achievement as the first Democratic President to win re-election since Franklin D. Roosevelt must be acknowledged. Much of his success and popularity was largely due the prolonged period of economic growth throughout his time in office. The focal points of Clinton’s economic policies included deficit reduction, tax-hikes, and welfare reform. He famously quipped that “[the government will] give you opportunity, but you have to take responsibility”, signaling his position on the welfare system that yielded waves of inefficiency. This was the beginning of what would arguably become his greatest achievement in office. On the aggregate, the Clinton Administration created over 21 million jobs, brought unemployment down to 4.0%, transformed the budget deficit into a surplus, and lowered the poverty rate. Although President Clinton’s time in office will be forever associated with an aura of despondency, the economic prosperity that was enjoyed across the country is testament to his economic efforts.

George W. Bush (2001-2009)

George W. Bush’s time in office was preceded by the technology bubble, which famously wreaked havoc on the equity markets when venture capital-funded internet-based companies collapsed with little notice. The economy and a geo-political situation that President Bush inherited would be the driving factors that impacted the country’s economic growth prospects during his administration. Unlike his predecessors, President Bush dealt with two economic recessions, the latter of which leaving a more substantial impact than the Great Depression. While the recession in 2001 was caused by a rise in unemployment, the administration’s efforts to successfully combat it was heavily impaired by the 9/11 Terrorist Attacks. The 2008 Financial Crisis was a bi-product of both the Bankruptcy Prevention Act of 2005 and the Subprime Mortgage Crisis. Much of the damage came from a period of excessive regulatory flexibility that the Bush Administration introduced, however, the 9/11 Terrorist Attacks also played a significant role in exacerbating the economic peril. The evolution of foreign policy under President Bush, and the subsequent $850 Billion that was spent to manage and handle the resulting conflicts abroad significantly contributed to the aggregate increase to the national debt.

Barack Obama (2009-2017)

President Obama’s honeymoon phase didn’t last long, given his inheritance of the biggest Financial Crisis in United States History. To his credit, President Obama made swift and sweeping policy enactments. Although the direction that these policy implementations would take the economy was considered a bit of a leap of faith, it eventually resulted in a positive outcome. The American Recovery and Reinvestment Act was an economic stimulus bill that reinvested close to $800 billion back in to the economy. As GDP growth became positive after multiple contractionary quarters for the first time since The Great Depression, businesses focused on adjusting to new production and supply levels to meet rising demand for consumer goods and services. The Obama Administration was also responsible for a hefty $850 Billion tax cut which added to President Bush’s stimulus package, increased unemployment benefits, and gave corporations tax cuts and credits for infrastructure projects and advancements in research. The appointment of Janet Yellen ushered in, and held steady, the lowest interest rates that the United States had seen in 200 years. While President Obama is extensively criticized for his sizeable additions to the national debt, his decisions were necessary as a means to bring the economy out of immediate turmoil, and were responsible for almost a decade of robust growth.

The Interim: The Federal Reserve’s Inflationary Concerns and Trump’s Fiscal Stimulus

The Federal Reserve has kept interest rates at historically low levels over the past decade as a way to supplement low inflation. However, newly appointed Chair of the Fed Jerome Powell, is faced with a new predicament. The last several years have increased concerns about the likelihood of looming accelerated inflation, and the role of the Federal Reserve will be to enact measures that tighten monetary policy. While an interest rate hike at the March 20-21 Policy meeting seems imminent as a result of wide-ranging increases in household costs, the question of whether the Fed should allow inflation to rise above 2% (considering the extended period of time where inflation was well below 2%) is resulting in a heated discussion on Capitol Hill.

Much of the rhetoric coming out of the White House regarding the budget proposal, stimulus package, and overall vision for the economy is largely revolving around the notion that the economy must see growth before inflation, and interest rates, result in disruption. The Trump Budget Proposal indicates an opportunity to cut the federal budget deficit by close to $3 Trillion over the next ten years, contingent on several speculative assumptions. Many of the provisions associated with tax reform itself indicate that the needle on the budget deficit could be pushed even further. While in theory the Republican economic agenda, which is positioned around driving long term economic growth through tax cuts for business and infrastructure-spending, might have an opportunity to tackle national debt, higher interest rates could be counter-productive to all of President Trump’s fiscal stimulus.

The Horizon: Long Term Economic Growth Prospects and Damage Mitigation

The interest rate cycle, inflationary trends, and the financial industry in general are far from an exact science. Projections involve the use of several qualitative trends that are modeled based on socio-economic and geo-political concerns. This results in cognitive judgement biases, irrespective of political affiliation. At a time where the United States is once again confronted with volatility amid multiple foreign policy concerns, domestic capital and consumer market trends are not the only factors that affect the way both the Fed and the White House view the trajectory of the economy. Much of President Trump’s new budget proposal is based on the brazen assumption of 3% economic growth, which deviates quite substantially from both Wall Street and Capitol Hill forecasts. When an interest hike does indeed occur, it could result in a considerable adjustment to the long-term budget and limited productivity from the stimulus package.

Retrospectively, there is much to applaud and appreciate with respect to economic growth over the last few years. The Trump Administration is in a much more favorable position to implement long-lasting, wide-ranging economic policy initiatives, but the rate of success will be largely dependent on the administration’s ability to adequately predict and react to changes in the long-term. As the unemployment rate drops and the labor force moves toward full employment, and as prices associated with household consumption increase, the very stark reality of an economic “bust” lies ahead if the government does not tread carefully. Both the Federal Reserve and the White House will be in the spotlight as timing, direction, and uniformity become be vital components for developing a strategy to ensure stable long-term growth potential without derailing accelerated growth in the interim.

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