18/06/2021

What Will Bidenomics Mean for the US?

Three questions to Dino Kos and Eric Chaney

America Economy

Eric Chaney

Senior Fellow - Economy

Dino Kos

Senior advisor at CLS Bank International

The commitment of the Biden administration to bring about fiscal boosts and spending programs seemingly marks a policy shift. The repercussions of these decisions could be varied, from encouraging new infrastructure and development, to impacting competitiveness and causing a further spike in inflation, all of which are also likely to have an international impact. In this cross interview, Dino Kos, Executive Vice President at CLS Group and former Executive Vice President of the Markets Group at the Federal Reserve Bank of New York, and Eric Chaney, Economic Advisor to Institut Montaigne, discuss the potential consequences of the Biden’s neo-Rooseveltian policy.

President Biden has set in motion three large scale spending programs, a rescue plan worth 9% of GDP already kicking in, a job plan and a family plan. What could be the growth impact of these measures on the US economy and more broadly on the global economy, if emulated in other regions?

Dino Kos:

The Biden Administration’s economic policy has three primary pillars. The first is to foster a full economic recovery after the devastation of the pandemic, including a return to the low unemployment rates that prevailed before the economic lockdown of early 2020. This includes aggressive fiscal spending and a vast expansion of the budget deficit. The second pillar is to increase potential growth by investing in infrastructure, especially roads, bridges, airports, broadband access, among others. This will primarily be financed with new borrowing, taking advantage of historically low interest rates. Finally, the third pillar is to re-work the tax code to reduce inequality between the highest income groups and the rest.

Each has its own political and policy challenges, though elements of all three will be implemented, even if some - such as infrastructure - are scaled down in size. Nonetheless, in the near term this policy mix is already stimulating economic growth in the US and will continue to do so in the future. Some of that must be spilling over to close economic partners. China’s strong exports suggest that spillover is being felt, and probably by others as well.

Eric Chaney:

In the near term this policy mix is already stimulating economic growth in the US.

Seen from overseas, the US expansionary fiscal policy has several implications. All things being equal, the US fiscal stimulus is comparable to what is being applied in Europe. According to OECD estimates, the US budget balance should deteriorate by 9.2% of GDP between 2019 and 2021, vs. 9.8% for Italy or 6% for Germany.

Yet, because of its sheer magnitude, $2 trillion by the same metric, the US fiscal boost is pulling the global economy via stronger demand for foreign made goods and services. China and Germany are already benefiting from the dollar manna, thanks to their own strong export sectors. On the other hand, the associated massive issuance of federal debt has triggered a significant rise in long term interest rates, partly transmitted from the US bond market to Europe. Yet, since the rise in bond yields is generated by stronger demand, not by more elevated market risks, trade linkages are significantly more powerful than the coupling of bond markets. Therefore, on a net basis, the US fiscal stimulus is largely positive for Europe.

Both actual inflation and inflation expectations are rising in the US, as the economy recovers from the Covid-19 strain. With both fiscal and monetary policy geared toward stimulating demand, what is your assessment of the risk of inflation being more than transient in the US? Is there a risk of inflation becoming a global matter of concern?

Dino Kos:

This is the most important question confronting markets at the moment. Is the Fed right to view the recent spike in inflation as transitory? It’s a reasonable bet to make from a central banking "risk management" perspective. Even if Chairman Powell is wrong, his calculus is that the Fed can take action (i.e., tighten monetary policy) to reverse any medium term increase in inflation expectations. The risk of course is that recent shortages of various commodities is not a temporary phenomenon, but a harbinger of rising prices more generally. If the Fed responds "too late" then they risk having to "chase" inflation and each incremental interest rate increase will be insufficient to catch up with the new higher level of inflation and real rates will stay too low. This describes Fed policy in the 1970s. Although a low probability scenario for this cycle, if it were to play out, the rest of the globe could not avoid being impacted as well.

Eric Chaney:

On top of the shortages and bottlenecks created by a surprisingly strong recovery of global trade - something most companies had not anticipated - super expansionary fiscal and monetary policies in the US, but also in Europe, cannot but generate inflation. This is exactly what we are witnessing. Will it be a transitory phenomenon? It is too early to say, in my view. The new consensus emerging among policy makers is that government debts are not a serious cause for concern and deflationary forces are structural, whereas the current bout of inflation is cyclical.

Super expansionary fiscal and monetary policies in the US, but also in Europe, cannot but generate inflation.

The risk I see is that this may fuel monetary complacency. Secretary of the Treasury Janet Yellen said that inflation was not a problem … since the Fed has all the levers in hand to contain it. That central banks have the means to prevent inflation from becoming endemic is not disputable. Yet will they do the right thing if inflation becomes entrenched? With government debts reaching levels not seen even in war times, political pressures against monetary tightening are likely to increase, and it is hard to predict what central bankers, starting with the Fed, will do. Hence, endemic inflation should be seen as a risk for the coming years, though not a central case scenario, in my view.

Beyond its stimulus dimension, the Biden administration’s spending programs put some emphasis on the necessity to create well paid and unionized jobs, plan to subsidize some industries and to increase taxes on corporations. What is the risk of the US losing competitiveness, with a less flexible labor market and less incentives to innovate? From a global perspective, is there a risk of regulation going too far?

Dino Kos:

The Biden Administration will be less friendly to business compared to the last administration, both in tone and in substance. Corporate taxes will rise somewhat, but less than what the Democratic left-wing would like. Minimum wages will rise (in many states they already have) and this is consistent with the third pillar mentioned above to reduce inequality. These measures will reduce margins and thus profitability but, I would argue, not competitiveness. Innovation is not suffering and is unlikely to in the coming years. Indeed, just recently, Congress - quietly and surprisingly - passed a $250 billion bill to fund basic research and investment in semiconductors, quantum computing, artificial intelligence, and other technologies of the future. Why was this passed? One word: China. This suggests that even in a divided time in the US, the legislature realizes that the competitive threat from China is real and is responding with funding to make the US more competitive in the technologies that will determine global leadership in the next generation.

Eric Chaney:

We are already hearing some European politicians boasting that "the US is drifting toward European standards in terms of economic and welfare policy". Though this is true in terms of direction - as Dino explained earlier, the US administration is going to spend more on infrastructures, schools, families, protected jobs, and to raise taxes - there is still a wide gap between the US and most European countries in terms of government intervention in the economy, beyond the size of the budget. Whether Biden’s neo-Rooseveltian policy will act as a drag on US companies’ competitiveness is disputable. However, I would be more pessimistic for Europe: the new US policy may encourage some governments, or political parties competing for power, to regulate the private sector ever more heavily, at the expense of competitiveness and eventually welfare. Competition with China may be seen as calling for more public spending on basic research in the US - an excellent piece of news - but that is not the case in Europe, where competition with China is seen by most politicians as calling for more protectionism, not more innovation.

Copyright: Nicholas Kamm / AFP