Federal Reserve officials are showing surprise at just how much the recently-enacted tax cuts are boosting the U.S. economy. But they’re still not impressed enough to lift estimates for long-term growth, a stance that puts them at odds with the White House.
Minutes from the Jan. 30-31 meeting of the Federal Open Market Committee, released this week, showed “a number” of policy makers had already upgraded their month-old outlooks for growth in 2018, citing an impact from tax changes “somewhat larger in the near term than previously thought.”
Missing, however, were any hints that committee members believe those tax cuts will elevate the speed at which the economy can grow in the long run without sparking faster price gains. The Trump administration, by contrast, expects a pickup in growth and no significant rise in inflation, a position taken this week by Treasury Secretary Steven Mnuchin.
With unemployment already the lowest since 2000, the Fed’s outlook implies that greater expansion would risk overheating the economy and potentially warrant a faster pace of interest-rate increases, thereby blunting the effect of the tax changes. Lawmakers could potentially question Fed Chairman Jerome Powell on these issues when he testifies before Congress next week in his first hearings as central bank chief.
“To get a lasting effect you want to see it raise investment growth and push productivity,” thereby boosting the economy’s “supply side,” said Peter Hooper, a former senior Fed staffer and now chief economist at Deutsche Bank Securities in New York. “I don’t see any really hard-core supply-side enthusiasts on the FOMC,” he said.
Congress passed, and President Donald Trump signed, the legislation in December, lowering personal and corporate profit tax rates. Fed officials, with a couple of exceptions, have been cautious in estimating how that would affect the economy. Yet reports gathered by regional Fed banks from companies in their districts appear to be coming in more positive than expected.
Loretta Mester, president of the Cleveland Fed, has said that type of feedback has prompted her to consider working extra growth into her forecasts for 2018 and 2019 after already adding as much as 0.5 percentage point for each year.
The minutes hinted at more of that. Officials “characterized their business contacts as generally upbeat about the economy,” citing tax cuts and an improved global economic outlook.
“They were caught off guard a little bit by the response,” said Stephen Stanley, chief economist at Amherst Pierpont Securities in New York. He said Fed officials were making a mistake in not predicting a supply-side impact.
“The Fed is positioned to underestimate the effects of the tax changes,” he said. “This does change the economics of investing for corporations.”
Officials will have to make their views clearer when they issue their next set of quarterly forecasts in March. The minutes strongly suggest that the median forecast for 2018 economic growth will rise from the 2.5 percent submitted in December. A bigger surprise would come if they also upgraded their “longer-run” forecast of 1.8 percent.
Randal Quarles, appointed by Trump as a Fed governor, has been decidedly optimistic about the potential for lasting supply-side improvements. In a speech Thursday, he said a five-year drought in business investment “may finally be breaking.” St. Louis Fed chief James Bullard has also said the tax cuts could potentially lift productivity by encouraging more investment. Other officials have so far been more cautious.
Vincent Reinhart, another former Fed senior staffer and now chief economist at Standish Mellon Asset Management in Boston, said even if more FOMC members were inclined to start talking about higher longer-run growth, the January FOMC session was an unlikely time to start, given that it was the last presided over by Chair Janet Yellen.
Yellen has expressed skepticism that the tax package would significantly raise her estimate of the economy’s historically low trend growth rate.
With Yellen out of the picture and Powell taking over, Reinhart said, “That means there is scope for some surprise in March.”
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