Federal Reserve board members wrestled with how much of an economic impact to expect from Donald Trump’s tax cuts as they raised rates last month and continued to be flummoxed by persistent low inflation, according to minutes released on Wednesday.
The new minutes highlight how the impact of the slashing of the US corporate tax rate and other tax changes passed by Congress in December has emerged as one of the biggest questions hanging over the world’s largest economy this year.
Mr Trump and his Republican cheerleaders argue that a surge in business investment and wage rises prompted by the tax reforms will boost US GDP growth to 4 per cent or better.
But during discussions at their December 12-13 meeting Fed policymakers predicted a more modest impact to growth. In economic projections released alongside last month’s rate decision, members of the Federal Reserve board and presidents of its member regional banks said they expected real GDP growth of just 2.2-2.6 per cent this year, with a median expectation of 2.5 per cent growth for 2018.
Affecting that prediction was a debate over how much of an impact on business investment and consumer spending the tax changes will have.
“Many participants judged that the proposed changes in business taxes, if enacted, would likely provide a modest boost to capital spending, although the magnitude of the effects was uncertain,” the minutes said.
Such an increase, they said, would have a positive effect on the potential growth of the US economy, which has stalled in recent years.
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But they also pointed to surveys and conversations with business contacts that suggested any additional cash generated by the tax changes “was more likely to be used for mergers and acquisitions or for debt reduction and stock buybacks.”
While participants expected “moderate growth” in consumer spending in the near term and for cuts in personal taxes “to provide some boost”, according to the minutes, they disagreed on how much impact the then-anticipated tax changes were having already.
“A few participants noted that expectations of tax reform may have already raised consumer spending somewhat to the extent that those expectations had spurred increases in asset valuations and household net worth,” the minutes said. But “a number of participants expressed uncertainty about the magnitude of the effects of tax reform on consumer spending.”
The minutes also point to how the Fed’s policymakers continue to focus on the puzzle of low US inflation, which remains below the Fed’s 2 per cent target rate. Those concerns led two members — Charles Evans and Neel Kashkari — to vote against raising rates at the December meeting.
“Many” of the meeting’s participants said they expected a tightening labour market to lead to higher wages and feed through to higher inflation in the medium term, pointing to what they see as transitory factors working their way through the economy.
“These participants generally judged that much of the softness in core inflation this year reflected transitory factors and that inflation would begin to rise as the influence of these factors waned,” the minutes said.
But one Fed member pointed to the impact on inflation of “secular trends, such as technological innovation or globalisation” and other members raised the possibility that the Fed could be dealing with the impact of low inflation for some time to come.
“With core inflation readings having moved down [in 2017] and remaining well below 2 per cent, some participants observed that there was a possibility that inflation might stay below the objective for longer than they currently expected,” the minutes reported. “Several of them expressed concern that persistently weak inflation may have led to a decline in longer-term inflation expectations.”
The Fed raised its target rate by 25 basis points last month and most analysts expect its policymakers to raise rates three more times this year.