When the GOP tax cut was first proposed I argued that the only way to make it realistic was for the Fed to accommodate more borrowing.
I realize that at this stage in the game the GOP leadership is more focused on getting the Congressional Budget Office to score its tax cuts as highly stimulative [on the supply side]. Yet, on some level surely it wants the tax cuts to actually be stimulating [including on the demand side]. That requires a Fed that is willing to at least tentatively accommodate the extra borrowing those tax cuts will produce and wait for inflation to show up before interest rates.
Further, I argued that my fellow economists insistences that higher interest rates would offset any potential growth gains and this stimulus was ill timed were misguided.
We still have infrastructure to do and if need be, be deficit financed. Secular stagnation and the possibility of Japanification remain our top concerns and should be approached through a multi pronged strategy including CIT cuts, infrastructure and running the economy hot
— Karl Smith ? (@karlbykarlsmith) November 20, 2017
This morning Greg Ip writes in the WSJ
With U.S. unemployment at 4.1% and the economy at full capacity, the conventional wisdom is that this is the wrong time for Republicans to cut taxes by $1.4 trillion over the next decade. The fiscal stimulus will overheat the economy and force the Federal Reserve to slow it down by raising interest rates more aggressively.
That conventional wisdom may be wrong. Fed officials, in the projections released yesterday and in Chairwoman Janet Yellen’s remarks, suggest they aren’t standing in the way of any boost that the tax cut delivers. Indeed, it may not be entirely unwelcome.
The reasons are twofold. One is that inflation is still too low, and that completely changes the equation: It suggests overheating is to be welcomed, not resisted. The other is that officials are open to the possibility that the tax cut will raise the economy’s potential growth rate, which means faster growth wouldn’t necessarily lead to more inflation.
Indeed, Ip reports that the Fed is willing to give the tax cuts room to do their thing:
Ms. Yellen said. In other words, it doesn’t matter much what the Fed thinks right now about what the tax cut will accomplish; it will let the data answer that question and adjust interest rates accordingly.
This outlook isn’t an endorsement. Ms. Yellen made it clear she didn’t agree with Mr. Trump and Treasury Secretary Steven Mnuchin that the tax cut would pay for itself, and warned it may be “taking what is already a significant [debt] problem and making it worse.”
I know many folks will focus on Yellen’s dismal of Trump and Mnuchin’s claims as well as her own skepticism on the wisdom of tax cuts, but we should be happy that she is willing to see what works. Analysts must be careful not to poison the well as we consider this tax package. It’s the last refugee of those who care are more about signaling general disapproval than actually determining what it best for the economy and pushing the government in that direction.
The reason to be skeptical about any argument Trump and Mnuchin offer is that they clearly display a limited grasp on policy. Indeed, I doubt they even understand what many of their own arguments mean. Yet, the inanity of the administration has nothing to do with whether or not the tax cuts are an good idea or part of an economic package could result in increased government revenues.
Reasonable people can disagree about what is best for the economy. Though I am defender of Kevin Hassett, I readily admit that his projections are rosy, bordering on the extraordinary. Yet, when facing secular stagnation and persistently low interest rates, we must not adopt a self-induced paralysis. The downside dangers to doing nothing far, far outweigh the upside dangers of having piled on a bit more debt.