Goldman sees the possibility of stagflation under Trump presidency

Bloomberg.- That’s the view of economists at Goldman Sachs Group Inc., who argue that while some of President-elect Donald Trump’s proposals could boost U.S. economic growth in the near future, his other policies would offset those positive impacts over the long-run.

Trump’s surprise victory in the presidential elections has spurred a rally in stocks and upped market-based expectations of inflation as the President-elect is expected to enact a host of tax cuts and boost infrastructure and defense spending that he says will jump start growth by 3.5 percent per year, on average. Still, the prospect of tighter trade and lower immigration under Trump’s presidency could raise the thorny prospect of “stagflation,” a scenario in which prices rise alongside unemployment while the economy slows.

“The positive fiscal impulse from his tax reform and infrastructure proposals could provide a near-term boost to growth and, depending on the specifics, could have positive longer-run supply side effects,” the Goldman team, led by economists Alec Phillips and Sven Jari Stehn, write. “However, other proposals could lead to new restrictions on foreign trade and immigration, which could have negative implications for growth, particularly over the longer term.”

Faced with lingering uncertainty over Trump’s policy proposals, the Goldman economists run through three different scenarios for the U.S. economy. The first is a “full” enactment of Trump’s campaign promises with everything from increased fiscal spending to trade restrictions included. The second is a “benign scenario” in which only Trump’s fiscal proposals are enacted. Lastly, there’s an “adverse scenario” in which trade and immigration are curbed while the Federal Reserve grows more hawkish.



Trump’s full policy package would boost annualized GDP growth by about 0.2 percentage points in the second-half of next year, though that would slow relative to Goldman’s baseline forecast after that — by as much as 0.5 percentage points in 2018 to 2019 as the Fed hikes rates to counter core inflation rising to 2.3 percent, the economists said. The benign scenario, meanwhile, would boost economic growth by as much as half a percentage point between 2017 and 2019 and deliver only marginally higher inflation.

Stagflation comes about via the adverse scenario as real GDP growth is 0.8 percentage points lower in 2018 and 2019 while inflation peaks at 2.3 percent in early 2019 and unemployment jumps to 5.3 percent. Under that scenario, the Fed would initially hike rates aggressively to fight inflation but would stop in 2019 as it tries to combat faltering economic growth and job losses.

Goldman isn’t the first bank to warn about the possibility of stagflation. HSBC Holdings Plc Chief U.S. Economist Kevin Logan wrote last week that: “If Trump does follow through on the full extent of his proposals, our economics team believes there could be a short-term boost to GDP growth from tax cuts and increased defense spending, but stagflation could quickly set in if import prices rise and the immigrant labor force contracts.”

Of course, the Goldman economists don’t expect all of Trump’s campaign promises to be fully enacted. Instead the economists forecast some scaled-down fiscal boosts, slowing immigration and more trade restrictions.

Under that scenario, tax cuts boost annualized GDP growth by 0.1 percentage points higher Goldman’s baseline forecast in the second half of next year but growth slows thereafter. From 2018 onward, U.S. GDP growth would be about 0.1 to 0.2 percentage points slower, Goldman says.

“The risks around our base case appear asymmetric,” Goldman warns. “A larger fiscal package could boost growth moderately more in the near term, but a more adverse policy mix would likely lead to a significant slowdown, higher inflation and tighter policy in subsequent years.”

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