Janet Yellen and The Fed’s Rate Hike(s)

The Mortgage Corner

The Federal Reserve on Wednesday raised a key U.S. interest rate for the first time in a year and signaled a more aggressive approach in 2017, when incoming president Donald Trump plans a so-called ‘full-throttle’ strategy to jack up the American economy.

Some economists think the tax cuts and increased spending plans put forward by the Trump team may trigger higher inflation and force the central bank to raise rates more aggressively. Others think the Fed may be able to accommodate some stimulus without reacting sharply, said observers of the Fed’s action.

Fed officials did not give many hints in their latest forecast for the economy. They still expect GDP growth to average 2 percent over the next three years, although the Trump Team forecasts 4 percent growth for years to come with their spending plans. The Fed also predicts unemployment will stay close to the 4.6 percent rate seen in November.

And inflation does seem to be picking up, even though at the consumer level it remains low. The Consumer Price Index that measures retail prices rose 0.2 percent in November with the year-on-year rate up 1 tenth to plus 1.7 percent. The core rate, which excludes food and energy, also rose 0.2 percent with this year-on-year unchanged at 2.1 percent.

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Graph: Econoday

This is not enough inflation to generate additional growth. Inflation levels in the Clinton and GW Bush administrations were in the 3 to 4 percent range before 4 percent GDP growth kicked in.

And the Trump economic team must also be promising higher inflation with higher growth projections, since they want to finance much of the stimulus with additional borrowing without raising taxes to support that debt, as the GW Bush administration did to finance its spending for the invasion and occupation of Iraq and Afghanistan.

Wall Street Economist Greg Ip disagrees that Trump’s plans won’t cause pain. “Donald Trump’s tax cuts would result in $6 trillion in lost revenue over the next decade, according to several independent analyses. His advisers disagree. They claim Mr. Trump’s entire program, including trade, regulation and energy, not just taxes, would generate so much growth there would be almost no increase in the deficit.

Their math doesn’t add up, Ip says. “It rests on aggressive, tenuous or flawed assumptions: that deficits caused by tax cuts don’t raise interest rates; that removing regulations adds directly to gross domestic product; that oil and gas companies will rush to drill on newly opened federal land regardless of energy prices; and that protectionism expands the economy even if U.S. companies and workers are already working flat out.”

We therefore should assume higher inflation will come with more stimulus spending, not always a bad thing if it creates enough new jobs in an economy already near full employment. That also means the Fed may keep its promise to raise their interest rates further next year.

Harlan Green © 2016

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

About populareconomicsblog

Harlan Green is editor/publisher of PopularEconomics.com, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
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