This is an excerpt from our most recent Economic Outlook report. To access the full PDF, please click here.
The U.S. economic patient is finally showing signs of life again. Seemingly, the patient is getting better and better with every release of new statistics.
A critical determinant to any sustainable growth path will remain accommodative monetary and fiscal policy. Fed Chair Jerome Powell has repeatedly reassured markets over the last few weeks the FOMC is not planning to take the foot off the pedal any time soon. Market participants should continue to expect the Fed to remain committed to providing an uber-supportive environment to foster economic growth. Any visible inflationary pressures likely remain temporary, throughout the upcoming year.
So far, this has indeed been the case. Increases in production costs have been absorbed by the supply side, not passed on to consumers. While this development alleviates concern about inflation ratcheting up, this effect might come back in the form of lower profit margins and, ultimately, lower earnings in upcoming quarters.
Fiscal policy has followed suit. With the latest round of stimulus checks barely in the mail, traders already moved on to price in the next item on the new administration’s agenda: the Infrastructure Plan. A medley of included items could provide long-term growth stimuli for a domestic economy that, for a long time, has been starving for broad infrastructure measures. Federal investment in domestic infrastructure has been declining since the 1960s. Such internal physical factors are the backbone of any economy, and are paramount for the competitiveness of the U.S. in a global economy.
However, successful implementation of infrastructure investment is more challenging than it sounds. Not to mention any plan still has to be passed by a very closely divided Congress. Unlike stimulus checks, which in old Keynesian fashion are put into the hands of consumers, to decide how to put that money to use, actors inside the U.S. government will be dealing with the challenge of identifying the most important projects: the ones that putatively promise the highest return on investment.
As if matters weren’t challenging enough, on top of the goal of supporting economic growth, $2.3 trillion in projects are meant to narrow racial, urban-rural and economic inequalities. This will add additional difficulties. Not only in selecting projects, but also in passing the legislation.
Finally, the big elephant in the room remains: How the measure will be financed? With long-term interest rates still near record low levels, any return on investment tied to these long-term projects does not have to be too high to allow for break even. This makes physical projects an attractive option, even with already highly elevated debt levels, which continue to become a bigger and bigger concern for investors.
The Biden administration has also put forward plans to raise corporate taxes. This was not met with a lot of enthusiasm by investors. Any hikes might have a negative effect of corporate activity, navigating revenue away from the U.S. -- in an attempt to avoid the tax hikes.
Tresury Secretary (and former Fed Chair) Janet Yellen’s call for a global minimum corporate tax rate might be a step in the right direction. In order to get U.S. incentives (or disincentives) off an unhealthy downward spiral -- of competing with other countries offering tax benefits to major multi-national companies.
With COVID still playing a foggy role, this remains a challenging environment for this plank of the new administration’s fiscal stimulus plans. But if done right, fresh, well-chosen infrastructure could set the U.S. economy on the right path for a decade of healthy and sustainable growth.
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