One of the Federal Reserve’s most influential members has offered a point-by-point critique of US President Donald Trump’s sweeping tax cuts, warning they put the country on an unsustainable fiscal path that will imperil the economy’s stability down the road.
New York Fed President William Dudley, a key architect of the US central bank’s decade-long response to the financial crisis, yesterday said the new cuts to corporate and individual taxes will provide a short-term boost but leave the economy more vulnerable in the years to come.
Not only could the bill eventually hurt US creditworthiness, it is unlikely to bring about spending since corporations and the rich benefit the most, he said.
The comments from Dudley — in which he maintained a “strong case” for the Fed to keep gradually raising interest rates — suggest that central bankers will not hesitate to criticise the tax plan’s timing and the economic assumptions of its Republican backers.
Other Fed officials have also raised alarms on the longer-term costs of the bill, though interviews with several of them in recent days suggest there is no appetite to adopt more or less aggressive rate hikes just yet.
“The economy has considerable forward momentum, monetary policy is still accommodative, financial conditions are easy, and fiscal policy is set to provide a boost.
But, there are some significant storm clouds over the longer term,” Dudley, who is set to step down in mid-2018, told a Wall Street forum hosted by SIFMA.
The tax cuts, he said, “will come at a cost. After all, there is no such thing as a free lunch.”
The legislation was signed into law last month as Trump’s first significant accomplishment as president.
It slashes corporate income tax by 14 percentage points and reduce individual rates mostly for higher-income households in what the administration argues will boost both business and consumer spending.
Yet with US unemployment low and economic growth robust, the bill could provide only a modest boost and, over 10 years, it is expected to balloon the deficit by $1.5tn.
Dudley, a permanent voting member on the Fed’s monetary policy committee and a close ally of outgoing Fed chair Janet Yellen, said record-breaking financial markets appear unconcerned that “the current fiscal path is unsustainable.” That means private investment could be crowded out, possibly eclipsing benefits from capital spending and potential output.
He noted that corporations and higher-income Americans are less inclined to spend, suggesting “a significant portion of the tax cuts will be saved not spent.” Zeroing in on a new cap on deducting state and local taxes, Dudley said the bill raises the cost of owning expensive properties in some areas and could diminish construction and prices.
“Over the longer term I am considerably more cautious about the economic outlook,” said Dudley, who last year also criticised the White House’s efforts to erect trade barriers.”Keeping the economy on a sustainable path may become more challenging” for the Fed due to the risk of “overheating,” he added.
On Wednesday, Dallas Fed President Robert Kaplan said he is concerned that after a short-term boost the economy will “tail off” and leave the government saddled with more debt and less means to pay it off. “My concern is it would create a future headwind for economic growth,” he told reporters in Dallas.
The central bank raised rates three times in 2017 and aims to do the same this year even while inflation has remained below a 2-percent target for more than five years.
Dudley repeated he expects prices to rebound this year toward the target, and said 2018 should be “a good year” for the economy.
He boosted his GDP expectations to between 2.5% to 2.75% growth, mostly due to the tax cuts.
In a wide-ranging speech to economists and investors, Dudley also dismissed concerns about a so-called flattening yield curve in which shorter-term bond rates rise and longer-term rates rise.
Though such a condition has repeatedly presaged past recessions, Dudley said he was “not convinced” of that this time, noting if it were not flattening the Fed would be “behind the curve” in raising rates.
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