With the 2024 election in the rear view mirror, we have a better picture of what policy for the next few years is going to look like. As such, we have a better idea on what to expect from the US economy over the next few years. That has largely colored my analysis this year. I do not wish to be political in this document, I am simply looking at the policy being proposed by the president elect and making conclusions based on my training as an economist about what that might mean for the US economy.
Consumer Spending
Consumer spending has largely held up over the last 4 years. Consumers have had a bit of whiplash between pent up demand during the pandemic, the post-pandemic splurge, and the increase in the rate of inflation. This whiplash has resulted in political ire, that fomented the return of Donald Trump to the white house. It appears that the average American is tired of inflation, and not only want to see inflation decline, but wants deflation. That being said, I think that consumer spending will likely hold so long as the unemployment remains relatively low which would buoy the economy.
However, my hedge is that I do not think that unemployment will remain low because of political reasons. The first Trump presidency was not exactly known for orderly predictable enactment of policy. This chaos could show up as shocks to the economic system resulting in largely unknown changes to employment status of the economy.
My actual concern, in terms of consumer spending, is with Elon Musk, and his pronouncement that we can eliminate approximately $2 trillion of government spending relatively easily. Certainly, there is waste in the federal budget, but even wastage has benefits to the economy through the government spending multiplier. Remember, estimates for the government spending multiplier range between 1.05 and 3.7 according to one model by the federal reserve (Halton and Sarte 2011). That means that reducing government spending by $2 trillion could reduce GDP by as much as $7.4 trillion! To put that into perspective I am forecasting around $30 trillion of GDP with no change in policy, this policy shift could result in between a 7% and an almost 25% reduction in GDP. It is hard to see how consumer spending would hold up in such a scenario. Such cuts to the overall economy would plant the US firmly in recession territory, and unemployment rates would jump upwards commensurately. Remember, that government spending results in income for someone else, and that person’s spending results in someone else having income. If the government stops spending, so will everyone else in the chain.
Taxes and Regulation
Upon hearing that Donald Trump had been reelected, the stock market jumped upwards. The stock market is not the economy, but it can tell us quite a bit about expectations that I largely agree with. The market jumped upwards from this news, basically because Donald Trump has vowed to keep the tax cuts from his first term, and to “delete regulations”. If this policy pronouncement were enacted it would indeed be a boon to businesses, which is likely why the markets reacted the way that they did.
I expect that the reduction in taxes and regulation will largely have an ambiguous effect on the economy at least in the short-run. However, in the long-run it will likely increase government deficits and result in long-run inflationary pressures. The mismanagement of government finances and regulations, via populist policies such as these, has been shown in Latin American countries to lead to spikes in inflation. However, as noted in the previous section this effect may be offset by the deflationary pressures of cutting government spending drastically.
A tax hike that Trump seems very fond of is the tariff. I actually do expect that the implementation of new, broad tariffs to result in higher costs to firms. Firms with pricing power will be able to pass these costs onto consumers. This will result in inflationary pressures on the economy as a whole. Firms that do not have pricing power will largely absorb the losses. Overall, my view on tariffs is that they are essentially a federal sales tax which is highly regressive and inefficient. My view is that these proposed tariffs will likely hurt the American public because they will only serve to reduce the supply of consumable goods in the economy,, and result in inflationary pressures. If done in concert with broad based cuts to government spending, will result in stagflation higher unemployment and higher prices offset by tax cuts elsewhere. However, additional tax cuts do not appear to be on the table, as a practical matter, rather just maintaining the current tax regime.
Overall, tax policy and deregulation attempts will likely have an ambiguous effect on the overall economy, and I’m not overly concerned about it. That being said, I do think that the proposed tax policy recklessly increases the risks in the economy, and would make the system more fragile as other economic forces get shocked.
Interest Rates
The Fed began cutting interest rates under Biden earlier this year. I feel that this trend is likely to continue. Rates will continue to be cut. These rate cuts will almost certainly ease pressures in the economy. However, it is very likely that the Fed will have to accelerate rate cuts as they will need to fight against declining GDP and rising unemployment if government spending is not decreased in a slow methodical way. Reckless job cuts at the federal level, will send shock waves through the economy, and the Fed will almost certainly feel the need to struggle against the cuts. If the government cuts are spread out over the entire term of Trump instead of a rash of reckless and needless cuts relatively quickly the effects could be mitigated.
I would expect that the Federal Reserve will find itself in a situation where interest rates will need to be brought to near the zero lower bound again. Trump has proven to be anything but methodical in his approach to government, and we have seen how Musk handled twitter. I expect that the decrease in government spending to be swift and at times abrupt. So I expect that interest rates will lag, but will also have large discontinuous decreases as well.
The declining interest rates will be a boon to individuals that hold assets such as stocks, bonds, and real estate. Especially, individuals that own bonds that were issued in the last few years. Bond prices will jump and that will carry stock prices withit.
Real Estate
I am currently projecting that real estate prices will remain at historically elevated levels. My outlook here is price stability. This is going to be mainly driven by the housing shortage across the country. The shortage of housing will likely be a bulwark against the backdrop of economic uncertainty. However, if unemployment reaches a tipping point, and consumers are unable to afford monthly payments, the housing market could begin to show weakness. Again, I think that the major problem is fragility. I think that the enactment of policies will lead to increased fragility in the US economy. We likely will not see much in terms of what could be called strength in the real estate market, but we probably won’t see much in terms of declines.
Geopolitics
The biggest concern is and will continue to be geopolitical instability. I think that war is generally bad for all involved. Ukraine, Gaza, and potentially Taiwan could lead to all sorts of negative effects for the US economy. Shocks to critical goods, such as energy products or semi-conductors, could have severe and unforeseen influences on the US economy. Worldwide instability necessarily will lead to instability in the United States.
Conclusion
My big takeaway is that this election has not improved the outlook on the US economy. However, I won’t go so far as to say we are doomed to a recession in 2025. My take is that we are in a very economically volatile period. The problem is risk. The election of Donald Trump to the white house, with a complicit Republican majority congress has increased the risks inherent to the US economy. My main worry is related to government spending. I don’t see a way to rapidly wind down our current levels of spending without triggering a severe recession.
If, on the other hand, the wind down in spending is choreographed and organized and gradual, I think that it can be done without too much of a negative impact. I personally doubt that the incoming administration will have the restraint to do so responsibly. Therefore, my outlook after the election is increased fragility of the US economy, larger government deficits caused by tax cuts and job losses resulting in lower government revenue are not off the table. I certainly do not think that the economy is going to be exactly healthy under Donald Trump, but I also am not forecasting an imminent recession. There will be a lot of uncertainty and fragility in 2025. Irresponsible policy changes are the real danger.
