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U.S. President Donald Trump has promised to put American workers first. (Olivier Douliery-Pool/Getty Images)
U.S. President Donald Trump has promised to put American workers first. (Olivier Douliery-Pool/Getty Images)

Trump’s ‘America first’ agenda raises the spectre of inflation Add to ...

U.S. President Donald Trump has promised to put American workers first. But he could end up hurting American consumers in the process.

Mr. Trump’s proposals on trade, taxes and infrastructure risk hitting Americans in the pocketbook though higher prices, say investors and economists. And that may set off a struggle with the Federal Reserve over the future of the U.S. economy.

The tension centres on how quickly the U.S. economy should be growing. Mr. Trump has pledged to take a series of measures intended to boost economic output, including cutting taxes, increasing spending on infrastructure and raising tariffs to shift production back to the United States.

The Fed, however, sees an economy that is running at a rate close to its current potential and nearing full employment. To increase the potential growth rate of the U.S. economy from here, in the Fed’s view, requires investments that enhance productivity, such as spending on education and training.

“When was the last time that the U.S. economy was as healthy as it is today and Washington began to talk about a stimulus cocktail of tax cuts and deregulation and government spending?” said Richard Bernstein, founder of an eponymous investment advisory firm in New York with $4-billion (U.S.) under management. “The answer to that question is never.”

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Mr. Bernstein said that he recently spoke with one of Mr. Trump’s advisers about the administration’s pro-growth rhetoric. He wanted to know whether the goal was to spur nominal economic growth – which includes inflation – or real growth, which excludes it. He didn’t get a response. “I think that’s the question every investor should be asking,” said Mr. Bernstein.

After years where inflation was unhealthily low, consumer prices in the United States have begun to perk up. In January, the latest reading for the Fed’s preferred price index was 1.9 per cent higher than a year earlier, which is close to the central bank’s target of 2 per cent. Last week the Fed announced the first of several expected interest-rate hikes this year, a reflection of its view that the economy is ready to exit the era of ultralow rates that has prevailed since the last recession.

Enter Mr. Trump. The President has yet to enact any significant economic legislation and is currently embroiled in a major battle to overhaul his predecessor’s health-care law. But the legislative agenda for this year is expected to include both corporate tax reform and an infrastructure package. Plus, the President has suggested that the United Staates could levy hefty tariffs on certain imported goods. On Saturday, the finance ministers of the Group of 20 nations released a joint statement notable for its failure to criticize protectionist policies in deference to the new U.S. administration.

While the details of Mr. Trump’s economic proposals remain unclear, the way he has described them suggests they will produce higher prices, raising the risk of a harmful outbreak of inflation. For instance, Mr. Trump has advocated higher spending on infrastructure combined with tax cuts. If those types of plans are implemented, they’re “likely to lead to higher inflation,” said Frederic Mishkin, an economist at Columbia Business School and a former Fed governor. “The Fed can actually choke some of that off … we’d be likely to get much higher interest rates than we have now.”

A different Republican proposal is already sparking fierce resistance due to its potential impact on prices. Paul Ryan, the speaker of the House of Representatives, wants to cut corporate taxes and reduce incentives to make things outside the United States. A key element of the plan is a “border-adjustment” tax. Under such a measure, the goods that companies import would face a 20-per-cent tax while their revenues from exports would be exempt from taxes.

Companies that rely on imported goods – such as retailers and energy companies – would pass those increased costs along to consumers. Some of the impact would be mitigated by a strengthening U.S. dollar, economists say, but not entirely. In a recent report, Deutsche Bank economists Matthew Luzzetti and Aditya Bhave predicted the measure would produce a temporary but sharp increase in inflation. They expect the measure to generate a jump of between 1.4 and 2.1 percentage points in the Fed’s preferred gauge of inflation in its first year.

Some brand-name U.S. companies – including Target Corp. – have already begun lobbying against the measure. The border-adjustment tax could produce “a direct hit on prices for the things that particularly middle and lower income households buy,” said Mark Zandi, chief economist of Moody’s Analytics. “I’d be surprised if it became law.”

Prof. Mishkin, the Columbia economist, noted that some of the administration’s policies could potentially reduce inflationary pressures. Its bid to decrease regulations, for instance, might allow firms to be more productive and bring more people into the work force.

In the meantime, the Fed will remain vigilant, keeping a close watch on measures of inflation expectations, which are crucial to the future direction of prices. If Fed policy makers “sense that they’re losing the confidence of investors, they would act very aggressively to restore that confidence,” said Mr. Zandi.

By this time next year, he predicted, inflation will be running above the Fed’s target. The true test of navigating the current policy environment, he suggested, will come for the next Fed chair: Janet Yellen’s term ends in February, 2018, and it is up to Mr. Trump to choose her successor.

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