Trump would make inflation worse. By Matthew Yglesias

www.slowboring.com

Nov. 20, 2023

12 - 15 minutes

There’s been incredible interest recently in the question of whether Americans’ perceptions of the economy align with reality.

To an extent, though, all the descriptive wrangling over both this question and its relevance to the 2024 campaign involve a set of facts on which sane people (unfortunately not as large a share of the commentariat as one would like) likely agree:

    The unemployment rate is low.

    Interest rates are high.

    Inflation is above target.

Whether you rate the current situation “good” or “bad” or “mixed” or “things are good but I’m mad about the big spike in inflation that happened and I don’t want to give Biden any credit,” we’d all like to see inflation and interest rates decline without unemployment rising.

And I think we’re on a trajectory where this is likely to happen.

Former Boston Federal Reserve President Eric Rosengren said last week that a soft landing is now his “base case,” which seems correct to me. That, again, doesn’t mean that you need to love Joe Biden or think the current economy is fabulous or forgive him for whatever policy errors you believe he committed in the past. But it does mean that when you consider a particular electoral outcome or world event or policy change, you should ask yourself whether that change is going to make things better or worse.

A huge regional war in the Middle East, for example, would clearly make things worse by disrupting global oil supplies. A miraculous peace deal between Russia and Ukraine would make things better by facilitating more global agricultural production. And most relevant to American voters as they think about the presidential election, implementing Donald Trump’s policy ideas1 would make things worse.

The press still largely covers Trump as an amusing sideshow, as if the world were stuck in a perpetual 2015, and the loudest critiques of this I hear call for more alarmist coverage of his authoritarian leanings. But I think the single most under covered story in American politics is about what you might call the “boring” stakes of the 2024 election. If the country elects Trump and a Republican congress and they implement their ideas on tax policy, trade, and immigration, what’s going to happen to the big economic variables that everyone cares about?

Because it seems to me that either they will make inflation and interest rates a lot higher, or else they’re going to be forced into the kind of draconian Social Security and Medicare cuts they claim not to want.

Even though Barack Obama signed significant fiscal stimulus into law in 2009-2010, these measures were insufficient to restore the economy to a state of full employment. In an ideal world, congressional Democrats would have structured the Affordable Care Act to front-load spending and provide additional stimulus. Failing that, the post-midterms White House probably should have been more accommodating of congressional Republicans’ desire for tax cuts (which would have been stimulative), if in exchange they could have gotten Republicans to agree to higher spending. Instead, Obama and House GOP leaders enacted a series of short-term austerity measures that slowed economic recovery.

The upshot is that even though growth was totally fine throughout Obama’s second term, the economy was still a little under-heated. Interest rates and inflation were consistently low (which was nice), but the labor market remained well below its pre-recession peak when Trump was inaugurated.

If you didn’t happen to know that the 2016 campaign was a dramatic moment in American political history, nothing about the economic trends would have suggested a significant break when Trump took office.

But with a Republican in the White House, congressional Republicans suddenly stopped caring about spending cuts and agreed to increase domestic spending, while also increasing military spending and cutting taxes. This did cause some Democrats to complain about the budget deficit, but I said it was fine and I was right. As the economy crept closer to full employment, interest rates started to go up, but only a little, and then declining demand from abroad sent them back down again until Covid changed everything.

It’s fascinating to ask what would have happened in American politics and policy had Covid not intervened, but that’s not a question we’ll ever be able to answer.

Instead, we had three years of Latin American-style macroeconomic populism under conditions that made this at best appropriate and at worst fine. Trump raised tariffs, for example, which tends to push prices up. But inflation was low, so nobody really noticed or cared. The tariffs generated retaliation from our trade partners, which was bad for American farmers, so Trump showered farmers with extra subsidies and, again, since interest rates were low nobody really noticed or cared. Then came a Covid-induced economic crisis, a series of massive stimulus bills, a rapid return to full employment, and a spike of inflation that was contained by a rapid surge in interest rates. It’s understandable that people have a certain nostalgia for the pre-Covid economy, but electing Trump is not going to reverse the linear passage of time.

Current circumstances are very different.

Inflation is back under control, but it’s still above the two percent target level. And to get inflation back under control, interest rates came up a lot. They came up high enough that it’s a real problem in the housing market, and also high enough that rising interest expenses are an issue for the federal government. In this environment, the centerpiece of the GOP economic agenda is an extension of the 2017 Tax Cuts and Jobs Act (TCJA) that will cost trillions of dollars and primarily benefit rich people.

According to the Committee for a Responsible Federal Budget, we are looking at $3.3 trillion in additional deficits from the direct loss of revenue and another $500 billion in increased interest costs. Trump would partially offset this with about $2 trillion in additional revenue raised by imposing an across-the-board tariff of 10 percent.

So we’d end up with somewhere between $1.3 and $1.8 trillion in higher deficits.

Tariffs, of course, are highly regressive, so despite the enormous tax cuts, lower-income families will end up paying higher taxes on net. And beyond that, tariffs have a distinct inflationary impact. You could raise $2 trillion with a relatively small across-the-board Value Added Tax that would make the price of almost everything a little bit higher. Alternatively, you can do it Trump’s way with a much higher 10 percent tax that’s only levied on foreign-made stuff.

To understand the impact of this on prices, consider a more specific policy, like a 10 percent tax on imported olive oil. That makes imported olive oil more expensive, and also raises some revenue. But it’s also going to raise the price of domestic olive oil, because price competition from foreigners has diminished. A portion of the higher consumer prices flows to the government as revenue, but another huge chunk of money is transferred from consumers to domestic olive oil producers as windfall profits. If investors are convinced that the tariffs are likely to last for a while, those windfall profits will attract capital investment into American olive oil, workers will transition into the field, and we’ll have a booming olive oil industry.

So now imagine doing this across the economy. The price of everything goes up. A fraction of those higher consumer prices flow to the government, and the rest goes as windfall profits to people who own American businesses. But you can’t attract new workers into producing everything simultaneously. That would just be inflation on top of inflation. And with the deficit soaring due to regressive tax cuts, interest are going to go up up up.

In a full employment, higher pressure economy, the country needs supply-side reform to generate further sustainable wage gains.

Biden has delivered on this in some areas, though unfortunately not to the extent that I would like. And here’s where you’d hope a Republican administration would sing. But the whole point of Trump’s politics is that relative to a traditional Republican, he’s not much of a free market reformer — his signature issue is immigration.

Despite fears early in his term, Trump didn’t meaningfully increase interior enforcement and deportations of long-settled residents of the United States, because enforcement resources were instead concentrated at the southern border. But this time around, Trump and his team have mapped out a plan that they believe will make it feasible for them to deport millions of people who’ve been living and working in this country for years.

I’m not sure whether their legal theories will pan out, but if they do, the upshot will be:

    Some amount of labor and other resources diverted away from current production and toward running the deportation apparatus.

    A shrinkage of the labor force, as unauthorized workers are forced out of the country. 

Trump is also planning to cut legal immigration, which would further shrink the labor force. This could have some disinflationary impact by opening up additional vacant housing units, but it’s a huge negative shock to the price of services and the productive capacity of the economy.

Someone is going to say, of course, “aha, Yglesias admits it, immigrants cut wages!” but living through several years of fights about inflation really ought to cure people of this. Of course many deported workers could be replaced by American citizens brought in at higher (nominal) wages. But that will push down real wages for everyone else via higher prices. More to the point, in a low-unemployment economy, the replacement workers will just be vacating some other job and need to be replaced themselves. The Fed will respond to this with higher interest rates to quell job openings.

Trump is just, in general, not much of a supply-sider.

He hates the idea of self-driving cars, and campaigned hard against zoning reform. Of course, in other areas, there’s no doubt a Trump administration will lean in a deregulatory direction. But even though there are a million little regulated areas, basically no amount of deregulation on the supply side is remotely capable of outweighing anti-supply moves on trade, immigration, and housing.

Keep in mind that due to population aging, each and every year the cost of Social Security, Medicare, and Medicaid rises as a share of the overall American economy. So if Trump is elected again, we’re talking about piling new policies that tend to raise interest rates on top of an underlying dynamic that pushes rates higher.

That’s bad news.

It’s also why George W. Bush was so keen to cut Social Security, and why Paul Ryan was desperate to cut Medicare. It’s not like those guys didn’t realize that these were politically dicey ideas. They didn’t propose them just for fun, they proposed them because it’s the only way to make the GOP tax cut agenda work. Trump says he doesn’t want to do political risky cuts, but he’s outlined an agenda that’s going to push the country into an interest rate crisis where pressure to enact severe cuts will be enormous. And that’s because it’s not just his fiscal policies — his overall policy approach is highly inflationary.

What the country actually needs, meanwhile, is policies that take the good news about the economy (full employment) into account and try to actually address the problems of high prices and high interest rates.

That means the opposite of Republicans’ bombs-away tax cuts. We should pair spending cuts with tax increases as a balanced, measured approach. And we should undertake pro-growth initiatives like returning to the bipartisan tradition of seeking freer trade and a more productive configuration of the global economy. We ought to expand legal immigration, especially to people who have valuable skills related to technology and health care, but more broadly to people working in critical services like child and elder care. We should reform land use policies to make housing more abundant.

And then, yes, we should call in some Republican economists to help go through the federal rulebook and pare-back laws with high costs and low benefits. But is Jones Act cheering Donald Trump going to make progress on that front? I’m skeptical. If you’re really excited about an administration that’s going to spend time litigating whether you can give drug dealers the death penalty, then it’s absolutely true that Trump is a charismatic channel for social conservative impulses. But if you’re actually worried about the economy, there’s nothing good happening there.