Insights from the 2017-2018 US fiscal stimulus

Under President Donald Trump, American fiscal policy has turned into a more expansionary mode, in a context where the economy was already close to full employment. More specifically, at the end of 2017, the United States government decided to ease the tax pressure weighing on companies and, to a lesser extent, on households (the Tax Cuts and Jobs Act or TCJA). In addition, at the beginning of 2018, it made a commitment to boost government expenditure for 2018 and 2019 (the Bipartisan Budget Act or BBA). As these measures are expected to cut public revenues and increase public expenditure, they are likely to fuel wider budget deficits and push up the American Federal State’s debt ratio.

According to the basic logic of conventional economic thinking, expansionary fiscal measures boost economic activity and a robust economy drives up prices. So, if that is the case, what economic impact has the recent US fiscal package had? This article seeks to answer that question while paying particular attention to the relationship between fiscal stimulus and inflation.

As for the initial impact observed, the response of macroeconomic variables so far seems to be rather limited. In 2018, the impact on economic growth was in line with the estimates, at around 0.6% of GDP. By contrast, inflation appears to have barely responded, which is not surprising as both theory and empirical evidence point to a mixed and rather weak link between fiscal stimulus and price developments.

It should nevertheless be borne in mind that it is very difficult to determine the precise impact of the fiscal measures, as other factors are likely to influence the economy at the same time. For example, over the period under review, US monetary policy was tightened noticeably, trade tariffs were raised and disinflationary pressures have been at play. All these elements may blur the effects of the fiscal stimulus on the economy.

While inflation in America seems to have scarcely reacted to the sizeable fiscal expansion, in the longer term, a scenario in which fiscally-induced inflation materialises can nevertheless not be dismissed altogether. The relationship between economic activity and inflation could in fact suddenly and rapidly gain strength in the context of an overheating economy. Moreover, in case of a reassessment of the sustainability of public debt, inflation expectations could be revised upwards.

Although the risk of a fiscally-induced upward drift in inflation (expectations) appears limited at the moment, the future impact of fiscal policy on price developments will not only depend upon US policy-makers’ future fiscal measures, but also on their communication about the path of the federal debt and on interactions between fiscal and monetary policies.