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When the Textbook Is Right: Implications of the Trump Fiscal/Trade Regime

Summary:
Today we learned that through March, the Federal budget deficit was 15% larger than the corresponding point in the last fiscal year — as expected given a not particularly stimulative tax cut (so much for tax cuts paying for themselves, as Stephen Moore claimed) and the ending of spending restraints. The dollar remains at elevated levels, as interest rates have risen. The trade deficit, excluding petroleum, continues to deteriorate. As I explained to my macro class today… it’s all textbook (notes). Figure 1: Federal structural budget balance as a share of potential GDP (dark blue, left scale), and projection (light blue), and ten year TIPS yield (red, right scale). Light orange shading denotes Trump administration, dashed line at passage of Tax Cut and Jobs Act. Source: CBO, Budget and

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Today we learned that through March, the Federal budget deficit was 15% larger than the corresponding point in the last fiscal year — as expected given a not particularly stimulative tax cut (so much for tax cuts paying for themselves, as Stephen Moore claimed) and the ending of spending restraints. The dollar remains at elevated levels, as interest rates have risen. The trade deficit, excluding petroleum, continues to deteriorate. As I explained to my macro class today… it’s all textbook (notes).

When the Textbook Is Right: Implications of the Trump Fiscal/Trade Regime

Figure 1: Federal structural budget balance as a share of potential GDP (dark blue, left scale), and projection (light blue), and ten year TIPS yield (red, right scale). Light orange shading denotes Trump administration, dashed line at passage of Tax Cut and Jobs Act. Source: CBO, Budget and Economic Outlook, January 2019, and Federal Reserve Board via FRED.

As the structural budget deficit deteriorated (1.4 ppts from 2017Q3-FY2019), real interest rates rose, roughly doubling.

When the Textbook Is Right: Implications of the Trump Fiscal/Trade Regime

Figure 2: Ten year TIPS yield (red, left scale), and real value of US dollar against broad basket of currencies, in logs, 1973Q1=0 (teal, right scale). Light orange shading denotes Trump administration, dashed line at passage of Tax Cut and Jobs Act. Source: Federal Reserve Board via FRED.

Rising real rates in the US lead to a dollar appreciation of about 6%. What did the appreciated dollar do?

When the Textbook Is Right: Implications of the Trump Fiscal/Trade Regime

Figure 3: Real value of US dollar against broad basket of currencies, in logs, 1973Q1=0 (teal, left scale), and net exports excluding petroleum as a share of GDP (black, right scale). Light orange shading denotes Trump administration, dashed line at passage of Tax Cut and Jobs Act. Source: Federal Reserve Board via FRED, and BEA, 2018Q4 final, and author’s calculations.

The trade balance (excluding petroleum) has continued to decline, nearly a half of a percentage point from 2017Q3 to 2018Q4. This is true despite the imposition of anti-dumping, national security and 301 duties, which were intended to induce expenditure switching. In other words, macro dominates…

Pretty much as I predicted 2-1/2 years ago.

(Outside the textbook — Trump trade policy induced uncertainty has probably induced appreciation of the dollar as well, further worsening the trade deficit.)

Menzie Chinn
He is Professor of Public Affairs and Economics at the University of Wisconsin, Madison

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