January 2, 2018

Chart of the Week: US Economic Sentiment Improves on the Back of Tax Progress

by Fathom Consulting

Our US Economic Sentiment Indicator (ESI) climbed from 6.0% to 6.2% in November, a nine-month high. Although gasoline prices rose during the month, consumer confidence remained strong as the labour market continued to improve. Meanwhile, business sentiment was buoyed by progress on tax reform. Since those surveys were conducted, tax reform has been signed into law. Since the reform includes large cuts to corporate and personal income tax, business and consumer confidence are likely to remain elevated in the coming months. Accordingly, we expect our ESI for December (scheduled for publication next week) to remain high.

Looking ahead, we expect real GDP growth to exceed 3% this year, which is not as fast as the rate of economic expansion currently implied by our ESI, but a lot higher than potential and higher than the recent past. The US will become a more attractive investment destination with its corporate tax rate now in line with that of most other OECD nations, although it remains to be seen just how much real economic activity moves to the US — some firms may exploit tax loopholes and simply book their profits there, without shifting the location of their production.

Wages and inflation will be boosted by the tax cuts, especially with the economy close to full employment, as the Phillips curve is not dead. However, the plan falls well short of the sort of stimulus that we think is required to generate a return to more normal rates of interest, and in so doing propel the US to a significantly higher growth path. Moreover, by overwhelmingly favouring the wealthiest, who have a lower-than-average marginal propensity to consume, the plan achieves less bang for its buck than it might have, and will increase income inequality, which is already being driven higher by technological change.

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