Donald Trump and the Federal Reserve Board

Last week, Republican presidential candidate Donald Trump released his plan for changing the tax code. Trump wants big across the board tax cuts, with the largest tax cuts going to the wealthy. He claimed that his tax cut won’t lead to a loss of revenue since it would lead to a huge spurt of economic growth. His number was 6.0 percent annual growth over the next decade, topping Jeb Bush’s 4.0 percent growth rate by two full percentage points.

Many of the reports on the plan commented on the growth assumption and pointed out that few, if any, economists took it seriously. As a practical matter, we have seen this story before. Ronald Reagan put in place a large tax cut in the 1980s and George W. Bush did the same in the last decade. You have to try very hard to find a positive growth effect from either. Certainly no one could make the case with a straight face that these sorts of tax cut proposals could even get us to Bush’s 4.0 percent number, much less Trump’s 6.0 percent.

But apart from what the tax cuts may or may not be able to do in terms of growth, there is also the matter of how the Federal Reserve Board would react. If that sounds strange, you should be very angry at the reporters at your favorite news outlet, because they should have been talking about this part of the picture.

Suppose that Donald Trump’s tax cut really is the magic elixir that would get the economy to grow 6.0 percent a year. But what if the people at the Fed’s Open Market Committee (FOMC) don’t recognize this fact? After all, many on the FOMC want to raise interest rates now because they think the economy’s current 2.0 percent growth rate is too fast.

If the FOMC thinks the economy is still bound by the pre-Trump tax cut rules then it will believe that inflation will start to accelerate out of control if the unemployment rate falls much below its current 5.1…

Read more