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Article by Bank of Greece Deputy Governor John (Iannis) Mourmouras entitled: “Trump’s economic start: Lessons of Reagonomics”

28/04/2017 - Articles & Interviews

Trump’s Economic Start: Lesson of Reaganomics

     The immediate reaction of financial markets to Trump’s win was positive not only at asset class level, but also within asset classes. Both equity and bond markets responded in classic fashion to prospects for higher growth, inflation and market inflows based on Trump’s campaign announcements on deregulation, tax reform and spending on infrastructure. This reaction occurred in
a remarkably orderly manner.
    Trumponomics will remain an important market influence, with investors particularly interested in two things: the transition from announcements to detailed design and implementation; and outcomes, particularly with regard to the relationship between higher growth and inflation. The expectation of a more active fiscal policy is based on the assumption that Trump will reinvent the package of policies known as ‘Reaganomics’.
    During much of President Ronald Reagan’s first administration, loose fiscal policy collided with a tight monetary stance as Paul Volcker, Fed chair in 1979-87, sought to squeeze inflation out of the system. This resulted in a seriously overvalued dollar. The strength of the dollar since the election is justifiable based on that historical analogy. Trump went as far as to say in April he thinks the dollar is ‘getting too strong, and partially that’s my fault because people have confidence in me.’ Regardless, capital inflows are expected to boost demand for dollar-denominated assets, irrespective of the economic outlook.
    However, there are two chief differences between the Reagan and Trump administrations. First, Reagan was fortunate in taking office in 1981, just after the 1979 oil shock had tipped the US economy into recession, so he started from a low base. In addition to a strong cyclical recovery, the US economy benefited as the oil price collapsed. As inflation came under control, policy interest rates came down. This produced a 35-year bond bull market. Trump, by contrast, entered the White House near the end of a mature, if fragile, expansion, with wages on the rise and little slack in the economy. On some estimates, the potential growth rate is as low as 1.5%, and there is a risk of inflation exceeding growth. Second, there is the issue of debt levels. Reagan presided over the start of a long surge in US public sector debt. Gross US public debt when Trump took office, at 105% of GDP, is more than twice the size it was when Reagan left office in 1989. These levels are unprecedented in peacetime.
    Externally, there is the question of trade policy and geopolitics. For economies with strong trade ties to the US, such as Canada and Mexico, as well as many emerging markets, open borders and mutually benefit al free trade agreements are of paramount importance. For the rest of the world, protectionism will have serious negative economic implications. Implementation of unilateralist measures would undermine the recovery in global trade and disrupt supply chains. The possibility of protectionist reprisals by other economies would have an adverse short-term cyclical impact and a negative structural impact on long-term growth.
    Underlying vulnerabilities remain for some large emerging markets. High corporate debt, weak bank balance sheets and thin policy buffers mean that these economies are exposed to tighter global financial conditions, capital flow reversals, and the implications of sharp currency depreciations, especially as a result of the strength of the dollar. This heightens their exposure to severe external shocks. When emerging economies last faced monetary tightening and fiscal loosening in the US, in the early 1980s, many sank into a decade of stagnation. If this happens again, it will not be good news – either for the world or for the US.

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