Will Feds Trump Trump?


President-elect Donald Trump’s promises to cut taxes and regulation, and to increase spending on infrastructure and defense, have convinced many that a false sense of security in the near term will boost the economy. But Fed officials say the economy is already expanding at something close to its maximum sustainable pace, meaning faster growth would drive inflation toward unwelcome levels.

To avoid overheating, the Fed could respond by raising interest rates more quickly. The more Mr. Trump stimulates growth, the faster the Fed is likely to increase rates.

“I guess I would argue that I think people have gotten a bit ahead of themselves about what a Trump presidency would mean,” said Lewis Alexander, chief United States economist at Nomura. “If we have a big stimulus, the logical thing for the Fed to do is to raise rates faster. There isn’t a whole heck of a lot of scope to just let the economy run under those circumstances. There’s a big question about whether fiscal stimulus under Trump just leads to higher interest rates.”

Fed officials also are increasingly convinced that steady job growth has substantially eliminated the post-recession backlog of people seeking work. The unemployment rate fell to 4.6% in November, a number pleasing to the Feds.

The tension between fiscal and monetary policy is likely to unfold in slow motion.

Mr. Trump has promised to press for rapid changes in government policy, but Congress is not built for speed.

Mark M. Zandi, chief economist at Moody’s Analytics, predicted that tax cuts, regulatory rollbacks and deficit-financed spending would fuel faster growth in the first half of Mr. Trump’s four-year term. But, he said that the Fed’s rate increases, and restrictions on trade and immigration, would gradually begin to take a larger toll. By the end, Mr. Zandi predicted, the American economy would be “unnervingly close” to recession.

“The Fed and markets in general will ultimately wash out any benefit,” Mr. Zandi said Monday. “The economy under President Trump ultimately will be diminished.”

Some of Mr. Trump’s proposals also could increase the economy’s potential growth rate, like improving infrastructure or encouraging corporate investment. On the other hand, the Fed’s march toward higher rates may be amplified by the bond market.

And there is always another hand.