One Obstacle for Trump’s Promises: This Isn’t the 2016 Economy

One Obstacle for Trump’s Promises: This Isn’t the 2016 Economy

When Donald J. Trump became president in 2017, prices had risen by about 5 percent over the previous four years. If he wins the race for the White House in 2024, he would take office at a time when prices have risen by 20 percent and continue to rise.

This is a very different economic backdrop for the kind of policies – tariffs and tax cuts – that the Republican candidate has placed at the heart of his campaign.

Trump regularly blames the Biden administration for the recent price increase, but inflation has been a global phenomenon since the coronavirus pandemic began in 2020. Supply chain problems, changing consumer behavior and other peculiarities related to lockdowns during the pandemic and its aftermath collided with stimulus-fueled demand and caused costs to soar.

The years of unusually high inflation that followed have changed the country's economic situation in important ways. Companies are used to adjusting their prices and consumers are more accustomed to these changes than before the pandemic, when costs remained stable for decades. In addition, the Federal Reserve raised the benchmark interest rate to 5.3 percent to curb demand and bring the situation under control.

This combination of nervous inflation expectations and higher interest rates could make many of the ideas Trump is touting during the campaign either riskier or more costly than before – especially at a time when the economy is running at full speed and unemployment is very low.

Trump is proposing tax cuts that could stimulate the economy and increase the budget deficit. That, in turn, could fuel inflation and increase the national debt — at a time when borrowing is very expensive for the government. He has talked about mass deportations, while economists warn that the loss of many potential workers could lead to labor shortages and rising prices. He is promising to raise tariffs across the board — and sharply on China — which could dramatically increase import prices.

And he has indicated that interest rates would be significantly lower under his leadership. That would be difficult for him to achieve, since the Fed sets its own rates and is insulated from the White House. But if Mr. Trump were to successfully try to undermine the Fed's independence and lower borrowing costs, there would be a risk that growth and prices would rise again.

The measures Trump is considering are an escalation of what he has tried before. Tax cuts that added to the country's debt, tariffs, immigration controls and verbal attacks on the Fed to pressure it to lower interest rates were all cornerstones of his first term. But the way the economy has evolved since then makes it a potentially dangerous time to repeat those measures in a more drastic form.

“It's one thing to have expansionary fiscal policy in a world with suboptimal inflation and unemployment below full employment,” said Mark Zandi, chief economist at Moody's Analytics and someone who provides research and analysis to the Biden administration. But this is a “very different economic backdrop,” Mr. Zandi said.

While both Presidents Biden and Trump are expected to continue running budget deficits if elected, several economic analyses suggest that Trump's policy proposals to date would result in a significantly larger budget gap. Researchers at investment bank TD Cowen said the choice between the candidates was between a “higher deficit” (Mr. Biden) and a “much higher deficit” (Mr. Trump).

There are good reasons why government spending would most likely continue to rise under either candidate: programs like Medicare and Social Security are getting more expensive as the population ages, interest costs are high, and even Biden has indicated he will extend individual tax cuts for people earning under $400,000—though he has also proposed tax increases on high-income households and corporations.

But the magnitudes differ significantly. An analysis by Moody's suggests that if Biden is re-elected with a divided Congress, the budget deficit is likely to stabilize at just over 5 percent of annual output in the coming years. If Trump wins the election and Republicans clearly dominate the election, it would rise to 6.4 percent, and if Trump wins the election and Congress is divided, it would rise to a lower 6 percent.

If the budget deficit remains stable, says Zandi of Moody's, the economy should remain on a relatively stable course. However, a higher deficit could give it a boost again.

And the annual deficits add to the country's debt mountain. Normally, periods of economic strength are seen as an opportunity to reduce the deficits and thus ensure that the national debt remains on a sustainable path.

“I think the minimum principle of our fiscal course should be: First, do no harm,” said Jason Furman, a Harvard economist who was an economic adviser in the Obama administration. “Unless there is one-time emergency spending, there is simply no excuse right now for measures that increase the deficit.”

This underscores an important point: This is not the economy that the two candidates originally inherited.

Mr. Trump took over an economy in 2017 with a still-recovering job market and low inflation. Mr. Biden oversaw an economy in the midst of a pandemic in early 2021. Whoever wins the 2024 election will face a very different backdrop. The economy is operating at or near full capacity, and the Fed has tried to slow it down with higher interest rates to bring inflation under control.

Although the labor market has cooled somewhat in recent months, unemployment has been at or below 4 percent since the end of 2021, the longest period of such low unemployment since the 1960s. While that changed in data released Friday, which showed unemployment rose slightly to 4.1 percent in June, that is still low by historical standards.

Wage growth has cooled but remains robust. Consumer spending is slowing but is still quite strong by historical standards.

And inflation, as defined by the personal consumption expenditures index, was 2.6 percent in May. While that's less than half the 2022 peak, it's still higher than the Fed's 2 percent target. Inflation is falling, but it's still rising faster than usual and could still be slightly elevated when the next president takes office, forecasts suggest.

For this reason, Trump’s policies are cause for concern, economists say.

“The economy is more at risk of entering an inflationary spiral today than it was in 2018,” when Trump launched a trade war, said Michael Strain, director of economic policy studies at the conservative American Enterprise Institute. “That should make us more cautious about any measures that could potentially let the inflation genie out of the bottle.”

Strain said he believes tariffs could drive up prices, but doubts they would trigger a series of price increases. He also said deporting immigrants could lead to inflation by creating labor shortages in some industries, but that depends on how the policy plays out.

Trump has announced plans to increase his tariffs by imposing import duties on nearly all trading partners, including a 60 percent tariff on all Chinese goods. Studies have concluded that his previous tariffs have increased costs for importers and consumers, and a recent analysis by the Peterson Institute for International Economics found that the new tariffs are likely to drive up price levels for imported goods and could cost a typical middle-income household about $1,700 annually.

On taxes, Trump promises to permanently extend the tax cuts for individuals that expire next year and talks about new cuts for workers who receive tips.

This could boost growth by leaving consumers with more money in their pockets than expected. And in a world of higher interest rates, the impact on budget deficits could be even greater. Trump's first tax cuts were financed with borrowed money, and analysts suspected that any extension or new tax cuts would follow suit.

The Congressional Budget Office already estimates that annual interest expenses on the national debt could rise to $1.7 trillion by 2034, nearly double today's levels. The Budget Office has estimated that if the expiring income tax provisions of the 2017 tax law were extended, deficits would be $3.3 trillion higher between 2025 and 2034, and higher interest expenses would be $467 billion.

Looking at Trump's agenda as a whole, “there couldn't be a more inflationary program,” says Kimberly Clausing, a nonresident senior fellow at the Peterson Institute and a former Treasury official in the Biden administration.

One question is whether the potential for inflationary policies under Trump would prompt the Fed to raise interest rates – or at least prevent it from cutting borrowing costs, as officials intend to do later this year and then repeatedly in 2025.

If Trump wins the election, “it won't really affect interest rates in the short term,” says Thierry Wizman, interest rate strategist at financial services firm Macquarie Group. The Fed would still likely cut interest rates later in the year as expected.

But it would change their view of the long-term trajectory, he said, and it would likely bias them toward an endpoint that is higher than it would otherwise have been.

Ana Swanson contributed reporting.