The economy, tax cuts, and the Federal Reserve (my 100th blog!)
The economy this year has been performing better than expected, due to the cumulative effects of the 2017 Tax Cuts and Jobs Act (TCJA). The corporate tax cut component of TCJA has resulted in many corporations investing in infrastructure (plants), training (people), and modernization (equipment). For example, Boeing committed to spending $300 million on training, facilities, and charitable activities, specifically because of the tax cut. In addition, consumers have had more money to spend, because of their reduced federal taxes, and consumer spending drives 70% of the Gross Domestic Product (GDP).
TCJA is an example of government fiscal stimulus to spur the economy. This type of act is usually implemented when the economy is in a recession, and something needs to be done to get the economy going again. What is different about the 2017 tax cuts, is that is was enacted when the economy was actually doing well. The result of these cuts was to increase economic growth from 2.5% in 2017 to 3.3% (so far) in 2018. Unemployment figures are now at historical lows of 3.7%, and the number of open jobs actually exceed the number of people looking for work. Isn’t that a good thing?
We have to look deeper at cause and effect to answer that question. The Federal Reserve is chartered and entrusted to promote a strong US economy by maximizing employment, maintaining stable prices, and stabilizing long term interest rates. One of the effects of extremely low unemployment is competition for resources, which means higher wages. As wages increase so does spending, which could drive prices higher for goods and services (supply and demand). This forces the Fed to increase interest rates to keep inflation in check (and maintain stable prices).
There is now a public debate in the media regarding the Fed’s actions, fueled in part by President Trump’s tweets against the Fed. Some say the Fed should stop raising rates, or they will cause a recession. Some say the Fed should raise rates higher, in order to keep inflation in check. Some are blaming the Fed’s actions for the recent downturn in the stock market. Regardless of what people say, think, or hope, the Fed has a mandate. As of today's Federal Open Market Committee (FOMC) meeting, the Fed is expecting the median Federal funds rate to increase to 2.9% in 2019. This implies they will raise the interest rate two more times (at a quarter point each) between now and the end 2019. Unless a significant event occurs that changes the economic landscape in 2019, I doubt the Fed will change course.