Key Issues

The near-term outlook. Unemployment is low, inflation is well contained, and growth is set to accelerate. During the course of this administration, the economy is expected to enter the longest expansion in recorded U.S. history.

Fiscal policy. The combination of revenue losses from the Tax Cuts and Jobs Act and the approved increase in spending will create a significant increase in the fiscal deficit in the next few years. This will add to an already-unsustainable public debt, contribute to a rise in global imbalances, and increase risks of future recession, with possibly negative outward spillovers. Further, the expansion in the deficit leaves few budget resources available to invest in a range of urgently needed supply-side reforms that could boost medium-term growth and raise living standards.

Monetary policy. Given the planned fiscal stimulus, the Federal Reserve will need to raise policy rates at a faster pace to achieve its dual mandate. In executing its monetary policy decisions, the Fed’s continued adherence to the principles of data dependence and clear communication will be vital.

Tax Policies. The Tax Cuts and Jobs Act contains many positive changes but these come with a high budgetary price tag. Many of the objectives of the Tax Cuts and Jobs Act could be better achieved by replacing lost revenues with increases in indirect taxes, targeting personal income tax relief solely to those earning close to or below the median income, imposing a higher tax rate on unrepatriated profits, reformulating the business tax as a cashflow tax, and redesigning the international provisions to impose a minimum tax on low-tax jurisdictions and to avoid giving more favorable treatment to exports than to imports and domestic sales.

Trade. The U.S should work constructively with its trading partners to reduce trade barriers and to resolve trade and investment disagreements without resorting to the imposition of tariff and non-tariff barriers.

Financial Regulations. Important gains have been made in strengthening the financial oversight structure since the global financial crisis and proposals to simplify regulations for smaller financial institutions represent further improvements. Future changes to financial oversight should ensure that the current risk-based approach to regulation, supervision and resolution is preserved.

Outward Spillovers. The net effect of U.S. policy choices—related to the budget and tax policy—will provide a near-term boost to trading partner output. However, those same policies as well as uncertainties about the trade regime have the potential to both increase the range and size of future risks and uncertainties faced by other countries and are likely to add to global imbalances. Insofar as the chosen policy mix prompts a tightening of global financial conditions, countries with high levels of U.S. dollar debt and/or a significant rollover need are likely to come under pressure. There is also a risk of a marked reversal of capital flows, particularly from emerging markets with weaker macroeconomic fundamentals, which could be disruptive. We are already starting to see symptoms of these negative spillover effects in some countries. These risks are added to by recent actions by the U.S. to impose tariffs on imports.

Approved By

Nigel Chalk (WHD) and Tam Bayoumi (SPR)