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Non-bad macro policy ideas in Trump interview

What would macro policy be like in a Donald Trump administration?  In a recent CNBC interview, Trump elaborated on his views on both monetary and fiscal policy.

The New York Times’s Upshot analyzes the views expressed by Trump:

a phone interview with CNBC on Thursday, he showed both the strengths and limitations of this background as he talked about the Federal Reserve, the dollar and the national debt in more detail than he has before.

But he also made an offhand comment that, if taken literally, would amount to rejecting the very underpinnings of the global financial system and would threaten to undermine the United States’ two centuries of creditworthiness.

Involved are one idea on monetary policy and two on fiscal policy. To start, a quote from Trump on his view of Janet Yellen, the chair of the Federal Reserve Board, gives us a sense of the Upshot’s point on monetary dovishness, or a preference to keep interest rates low to encourage employment and GDP growth:

She’s a low-interest-rate person, she’s always been a low-interest-rate person,” he said. “And I must be honest, I am a low-interest-rate person. If we raise interest rates, and if the dollar starts getting too strong, we’re going to have some very major problems.

The Upshot notes that this position stands “in contrast with many leading conservatives, like Paul Ryan and Ted Cruz, who have favored tighter money and a stronger dollar for the last several years.” Trump’s views on the matter would appear to be sound in principle, and indeed in line with Yellen’s. The Trump approach might permit unemployment to fall further, assuming lower rates increase spending on goods and services. A positive effect seems likely for at least two reasons: (1) Lower rates increase spending on durable consumer goods such as cars and homes, given that other variables are held constant, and (2) they help to reduce world demand for the dollar, lowering the value of this floating-exchange-rate currency.

The fiscal policy views quoted in the Upshot post consist of two proposals regarding the most desirable form of the debt, rather than on spending or taxation. The column’s analysis of the first Trump proposal would appear to involve a misunderstanding.

‘I’ve borrowed knowing that you can pay back with discounts,’ he said. He added, ‘Now we’re in a different situation with the country, but I would borrow knowing that if the economy crashed, you could make a deal.’

What he says he meant was buying back bonds at discounts after rates have risen, much as a company at risk of bankruptcy might buy its own bonds back at, say, 70 cents on the dollar and thus reduce what it owes.

The article goes on to criticize such a policy on the grounds that it would involve accepting the possibility of partial default on federal government debt, which would indeed be a foolish decision and perhaps against the law. However, it appears to me that Trump is advocating the use of debt contracts with an escape clause that insures against having to repay in full if adverse economic events and political circumstances somehow make repayment difficult.  The principal could in other words be reduced under the terms of the initial debt contract. Paying less back would not constitute a breach of such a contract, as foreseen by The Upshot. If this interpretation is correct, the Trump bonds would presumably be worth less than bonds with no escape clause and the same initial face value. Issuing such bonds would raise the costs of a given amount of debt, but would also provide the government more flexibility about the size of its debt payments, which expand the total size of balance sheets outside of the federal government and Federal Reserve System. This kind of instrument would serve as a tool of debt management (keeping interest costs low on a given debt) and of macro policy.

One question is whether some publicly observable event would need to occur to trigger the availability of this principal-reduction option. (Such provisions exist, for example, in some derivatives.) If not, the government might face an essentially political decision about whether to elect its principal-reduction option on a given bond. It might turn out, one would imagine, that the government almost never elected this option, given the risk of investor revolt–a possibility raised by some commentors on the Times site.

On the other hand, as a nation with its own unpegged currency, the US does not need such flexibility simply to be assured that it could meet its payment commitments, which are in dollars. This situation accounts for the fact that the US federal government has not defaulted in modern times, since the end of the gold standard. The Treasury, with the Fed, has the power to print checks and to create bank reserves, coins, and paper money—a situation that does not hold, for example, in U.S. states.

Second, as noted above, Trump reportedly advocated the use of longer-term debt. The issuance of longer-term liabilities would alleviate problems that arise mostly in the private sector when balance sheets suffer from maturity mismatch—the use of short-term liabilities to fund long-term assets. In fact, the distinguished financial-crisis theorist Hyman Minsky noted that this balance sheet structure was a key vulnerability of depository institutions and many other financial institutions.

Implementation of the second fiscal idea would bring both advantages and disadvantages: The interest rate on longer-term debt is usually higher than the rate offered on short-term debt, such as T-bills. At the same time, short-term debt implies interest-rate risk for both parties to the debt contract. Again, this approach does not solve a problem involving a lack of ability to meet payment commitments, including interest, at the federal level of government. Such a problem does not exist. On the other hand, lengthening the duration of the federal debt (more or less the average time to maturity of federal debt securities) provides insurance against a Fed policy move to raise interest rates. Such increases tend to raise the deficit, inclusive of interest payments, generating political pressure on Congress and the Administration to cut spending or raise taxes. Such pressures sometimes come from self-imposed budgetary rules.

It appears from all of these proposals that Trump fears the possibility of a Fed that takes a hawkish stance on inflation control, unduly tightening policy and threatening growth.

I wonder about the possibility of a Keynesian movement in the Democratic Party.


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