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Analysis

An inflationary president

Trump will lead to monetary normalisation 

by Miroslav Singer

Mon 21 Nov 2016

Election promises and post-election reality often diverge, but the broad themes defining Donald Trump’s presidency are unlikely to change.

A more relaxed fiscal policy is likely. This would ignite inflationary pressures and cause higher US interest rates. Given the dollar’s reserve currency dominance, the effects will be transmitted internationally through a stronger dollar, as we saw in the early 1980s and the late 1990s.

Such a monetary normalisation is, in principle, welcome – even though it may well lead to complications around the world.

Dollar appreciation would help improve the competitiveness of European Union economies, with the euro’s relative weakness likely to be accentuated by domestic European factors. Political events including the Italian referendum on 4 December and the French presidential election next spring are likely to counter any tendencies for a stronger euro.

Trump’s fiscal stimulus could prove to be a trend emulated by others, whether through their own initiative or pressure from the US.

An area to watch is defence. The president-elect warned that the US government might not help Nato allies that had failed to fulfil the alliance-wide commitment to spend 2% of GDP on defence. Many Nato members, including my home country, the Czech Republic, have been ignoring such pledges for over a decade. Irrespective of Trump’s warnings, even the EU is coming to grips with the reality that, given elevated global uncertainty, defence strengthening should take precedence over fiscal probity in countries that can afford such a change of direction.

The Czech and Slovak economies fall into this category. In addition, central European economies still possess relatively well-performing and capable defence sectors, as well as the requisite heavy industry able to supply the energy sector with the appropriate equipment when and if investments are renewed in this field. Government spending on defence and energy would thus exert a proportional impact on the rest of the economy through the fiscal multiplier.

So a Trump presidency could have some positive economic repercussions. But there are potential setbacks, not least in international trade. Trump’s trade-related election promises were directed at America’s traditional blue-collar manufacturing workers who believe they will benefit from protection from international competition. In his early post-election statements, the president-elect promised to protect the interests of energy production, construction, and infrastructure.

Trump pledged before the elections, too, to introduce restrictions such as higher tariffs on trade with countries such as China that are perceived to be drawing unfair advantages from their trade relations with the US. Conflicts of this nature would be a worrying prospect especially for small open economies of the sort we see in central Europe and Asia.

Such scenarios would weaken local currencies of countries hit by a trade slowdown. In combination with rising global inflationary pressures from US fiscal expansion, smaller economies face a surge in inflation once Trump assumes office, requiring a shift to tighter policies after years of monetary accommodation. Though welcomed by many, this may not be a smooth ride for all outside the US.

Miroslav Singer is former Governor of the Czech National Bank and a Member of the OMFIF Advisory Board. He lectures at CERGE-EI and the Prague School of Economics.

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