Economy weathers political storms in 2017, but tests lay ahead

The long-lasting U.S. economic expansion continued in 2017, demonstrating once again that economies can withstand even massive political upheaval for a while. Prospects for 2018 look like more of the same, but further down the road could be a good deal stormier.

During 2017, unemployment continued its many-year decline, reaching a low of 4.1 percent in November. Remarkably, the decline in unemployment to levels not seen since the 1990s has not been accompanied with palpable increases in inflation or wage growth.

{mosads}Growth remains moderate in the U.S., buoyed by a recovery in Europe and our other major trading partners. Going forward, stronger global growth might lead to stronger energy price growth, bumping up U.S. inflation.

Recovering home prices and soaring equity prices have created positive vibrations for many Americans. However, the wealthier segments of the population have been the main beneficiaries, since most share ownership is concentrated among a very small slice of the very wealthy.

Wage growth has been unspectacular. Real wages have grown about 2.5 percent. This is too low to lift incomes up very strongly, but also too low to cause major concern about inflation. Slow wage growth certainly is one of the explanations for the widespread perception that the economy really is not performing well, despite the long, steady recovery since 2009.

Despite candidate Trump’s brash and sweeping campaign promises, the new administration offered few significant economic policy initiatives in 2017. President Trump began the year by attempting to use his bully pulpit to prevent Carrier Corporation from relocating jobs to Mexico.

After achieving some nice headlines in this one case, he loudly proclaimed victory and focused on other things. Meanwhile, employers have largely continued doing what they had planned to do.

Other major items on the campaign agenda were either watered-down or put on the back burner. No new infrastructure plan was offered at all. Negotiations to modify the North American Free Trade Agreement began, but did not get far. To the relief of many, the administration did not move forward on the president’s bellicose protectionist rhetoric.

Despite the promise to “do a number” on the Dodd-Frank Act that strengthened financial regulation, the administration has only suggested relatively limited changes in the act. One big battle in the financial regulatory areas was joined, however.

Using the Congressional Review Act, the Consumer Financial Protection Bureau’s regulation eliminating mandatory arbitration clauses in basic consumer financial agreements was overturned. The bureau has been in the sights of congressional Republicans since its establishment.

In the wake of a massive case of fraud perpetrated on U.S. banking customers by Wells Fargo, it may seem strange that the administration is decreasing the powers of the new consumer financial advocate. But this administration has made it clear which side it is on.

The administration also had an opportunity to put its stamp on the Federal Reserve this year. No less than four places on the Board of Governors came open, including the chair. Surprisingly, President Trump nominated a relatively uncontroversial current Fed Board member, Jerome Powell, for chair.

He has also nominated a financial-industry friendly vice governor in charge of banking supervision, Randal Quarles, and a conservative former Richmond Fed research director Marvin Goodfriend.

The one and only major legislative accomplishment of 2017 was the tax bill. Passed with whirlwind speed and with amazingly little public deliberation, the new tax bill lowers the corporate tax rate from 35 percent to 21 percent, doubles the standard deduction on personal income tax, eliminates a welter of tax deductions, eliminates the corporate Alternative Minimum Tax, eliminates the Estate Tax and offers major tax breaks for a range of pass-through corporations.

While the bill is very complex and poorly understood (few details were made available in advance, and there is little doubt that contradictions and loopholes will be unearthed in the coming months), its broad effects seem clear. The lower corporate rate will raise corporate profits, benefitting shareholders. Numerous other provisions, above all the elimination of the estate tax, will benefit wealthy households.

The economic impacts of the tax bill are likely to be modest in the short-term, and substantially negative in the long-term. Corporations, already awash with cash, will most likely use most of the tax cut to buy back shares or distribute dividends.

They are unlikely to create significant numbers of new jobs or increase investments. Shareholders, mainly wealthy individuals, tend to save much more than people at lower levels of income, meaning that relatively smaller amounts will be spent on consumption goods. So, the overall impact on demand in the economy will be limited.

The only positive here is that the new bill offers so little stimulus to the economy that the economy will probably will not quickly tip into higher inflation, causing the Fed to raise interest rates sharply.

The ironic virtue of the tax cut’s ineffectiveness in the short run does not extend to the long-run. Over time, the lower corporate tax rates may increase corporate investment somewhat, but all of the other aspects of the bill that harm higher education, health care and renewable energy will hurt the economy.

These are among the key drivers of productivity growth, the most important factor underlying prosperity. The blow to the middle class could decrease market growth. Not to mention the social effects of the dramatic redistribution of income toward the wealthy that this tax bill creates.

Much discussion has focused on how the tax bill raises the deficit. A higher deficit leads to higher interest rates for private sector borrowers. However, in the extremely low-interest rate environment we are facing, this might not be a big issue.

Politics could negatively impact the economy in 2018 as well. My worry list includes drastic cuts in government spending, rationalized by the tax cuts, or rash moves to protectionism that promote retaliation.

Additionally, a tightening labor market, made tighter by harsh immigration policies that increase deportations and decrease both legal and illegal arrivals, could cause jumps in wages and prices. Less impactful but possibly jolting could be a major correction in equity prices.

Based on historical patterns, the next recession will come soon, but perhaps not in 2018. All in all, the biggest threat to economic stability is probably our leaders, not the economy itself.

Evan Kraft specializes in the economics of transition, monetary policy and banking issues as a professor at American University. He served as director of the research department and adviser to the governor of the Croatian National Bank.