In her final press conference on monetary policy, Federal Reserve Chair Janet Yellen gave substantial cover to President Donald Trump and Republicans in Congress for their ambitious tax reform. She characterised the effect of the fiscal stimulus as ‘modest’, providing at best ‘some lift’ to the economy in coming years. Most notably, it doesn’t change the Fed’s plans for a gradual increase in interest rates.
Her remarks came after the Federal Open Market Committee raised rates by another 25 basis points, the third such increase this year and the fifth since Yellen took over in 2014. They came, too, as Republicans moved to reconcile differences between the tax reform bills in the House and Senate, resurrecting the ancient concept of compromise, at least within the party. They pledged to have the bill passed and on the president’s desk to sign into law before Christmas.
Fed policy-makers revised their growth forecasts upwards, to 2.5% from 2.4% for this year, and to 2.5% from 2.1% for next year. But they did not accede to the administration’s projection of a substantial boost from the tax cuts. The main feature of the reform – cutting the corporate tax rate to 21% from 35% – is intended to spur investment and growth to recover lost revenue through increased economic activity. Most other forecasts expect the cuts to add at least $1tn to the federal deficit over 10 years, even if growth does increase.
But the Fed’s famous dot-plot graph forecasting interest rates still sees most policy-makers expecting a maximum of three rate increases next year, unchanged from September. Forecasts still look for rates to top out at 3% in the ‘longer run’. Two regional bank chiefs – Charles Evans of Chicago and Neel Kashkari of Minneapolis – dissented from the consensus at the meeting, voting to keep rates steady as inflation remains below the Fed’s 2% target.
When asked about Trump’s prediction that the cuts would propel growth to 4% and higher, Yellen, who will leave the Fed when her term as chair expires in February, quietly responded, ‘I wouldn’t want to rule anything out. It is challenging, however, to achieve growth of the levels that you mentioned.’
After dithering over the reform for months, congressional Republicans, perhaps spurred by the loss of a Senate seat in Alabama’s special election, reconciled their differences with surprising speed. They also responded to a political backlash against the proposal in both houses to eliminate the deduction of state and local taxes, instead extending the cap of $10,000 originally proposed for property tax deductions to state and local income tax as well. At the same time, they lowered the top marginal rate to 37% from 39.6% – lower than in either bill – to compensate for the partial loss of the deduction. Then to compensate for that, they nudged up the corporate rate to 21% from the 20% in the original text. Responding to an outcry from business interests, the compromise bill will eliminate the alternative minimum tax for corporations, which would have blocked many from benefiting from a tax credit for research and development and other tax breaks.
To the extent the tax reform does provide some fiscal stimulus, it may absolve the Fed for the puzzling failure of inflation to rise even as employment strengthens. Core inflation in November, as measured by the consumer price index, fell to 1.7% annual increase from 1.8% in October, one of the factors prompting the dissent from Evans and Kashkari.
For Yellen, however, any stimulus effect in an environment of ‘disturbingly low productivity growth’ would be ‘welcome’, spurring growth without requiring the Fed to tighten monetary policy immediately.
Darrell Delamaide is a writer and editor based in Washington.