Trump policy package would likely bring the US into recession
The effects of president-elect Trump’s proposed policy mix – of tax cuts and spending efficiencies, tariff increases, removal of illegal immigrants, and deregulation –are likely to tip the US economy into recession, according to the latest research by the National Institute of Economic and Social Research. In a worst case scenario, where immigrant expulsions are massive, tariff increases hit straight away and retaliation is swift and effective, GDP could contract by two to three percentage points, as against trend growth in potential of about 2%.
The study, by US economist and NIESR fellow Paul Mortimer-Lee, analyses these policies and considers the possible effects of a weakening in the independence of the Federal Reserve (Fed). It shows how potential benefits from supply-side policies, such as easing regulation, are more than offset by negative effects on growth of expelling immigrants and hiking import tariffs, even in the medium term.
Overall, the policy package is unambiguously inflationary, and could, if the Fed were to have less freedom of action, drive inflation to 7% or 8% by 2027. Loosening fiscal policy by about $1tn in terms of new measures (i.e., over and above extending existing tax rules) over the next 10 years will add slightly to demand pressures in an already full-employed economy. Conversely, import tariffs will directly increase prices (by 1% to 1.5% in the first year) and reduced labour supply as a result of even modest immigrant expulsions will push up wage costs and therefore prices (directly, by 0.25 to 0.5% per year for every year over the next several years).
How large the eventual inflation effect is and how long it lasts will depend on whether president-elect Trump succeeds in bending the Federal Reserve to his will, which would mean a softer monetary policy stance, a weaker dollar and increased risk premia in financial markets.
The current fiscal position is already very poor and is on an unsustainable path. The US federal deficit is close to 7% of GDP. Trump’s proposed tax cuts will send this even higher because they will reduce revenue by more than import tariffs will increase it, with the study projecting the debt-to-GDP ratio to rise to 134% in 2034, 12 points higher than the latest Congressional Budget Office (CBO) baseline.
Expelling large numbers of illegal immigrants who were already working in the US could have serious effects. Departures would disrupt industries like construction, retailing, agriculture and distribution. Expelling five million workers could reduce GDP by close to 2.5%. Since expulsions would continue for years, the reduced rate of growth in GDP would be persistent – not a one-off shock like tariffs.
Author of the report and NIESR fellow Paul Mortimer-Lee, said: “Overall, the proposed policy package by Trump is likely to be ill-considered, rushed, and damaging to the US and global economies. The United States in aggregate will lose, but there will be winners as well as losers.
Consumers will lose from higher prices, especially the poorest. Corporates and the rich will benefit from lower taxes and looser regulation. Those competing with imports and immigrant labour will gain. Oil companies will gain, but exporters and farmers will lose due to retaliation against tariffs, and the environment will suffer.
Given the President-Elect’s past performance and evident desire for radical change, uncertainty is likely to be high, which may also contribute to damaging economic growth and asset prices.”
