Forrest Cookson

After the financial collapse of 2007 the developed economies fell into recession. The extensive damage to the world's financial institutions was the major factor resulting in a rather slow recovery. In the United States monetary policy was very expansionary but investment was slow to recover as low interest rates were balanced by a very cautious approach to bank lending. The European Union (EU) recovered slowly as policy makers were unable to handle the great differences in performance among countries within the Euro zone.

Growth in the United States has been greater than in Europe, although the Republican Congress contributed to slow growth by refusing to use fiscal policy to support monetary policy. The actual output of the American economy is now near its potential output. As the potential output is approached one expects increased inflation and the Federal Reserve to raise interest rates to slow the economy and prevent inflation from growing past 2.0 per cent. We make five observations about the American economy and conclude with some thoughts on what this means for Bangladesh.

1. INFLATION IS RISING: The current level of inflation (CPI) in the USA has passed 2.0 per cent and is about equal to nominal wage growth; hence real wages are not growing at all. That is, the increase in wages is about the same as the increase in prices. This probably underestimates inflation as the cost of medical care and housing are under-represented in the CPI. The average American worker is now starting to feel worse off. Most workers gained nothing from the recent reduction in taxes. It is likely that the economic condition of most Americans is going to worsen over the next 12 months. However, the top 10 per cent of the income distribution are doing much better and have made substantial gains from both the growth of the economy and tax reductions. The Trump administration's economic policies, for all the hype, are now beginning to reduce the income of most Americans. The Federal Reserve will be slow to move against inflation so the stagnation of income for 90 per cent of Americans will continue for some time.

2. POOR MACRO-ECONOMIC POLICY: At the simplest level the Trump administration has carried out the worse possible macro-economic actions: With the economy virtually at potential output there has been a sharp increase in government expenditures and a reduction of taxes. This has increased the Government deficit and added pressure on the economy to grow just as it has reached the point that the economy cannot grow very fast. This is inflationary and the impact is now beginning to be felt. The efforts to moderate inflation will raise interest rates, increase the costs of servicing the very large debt, and increase the deficit, requiring higher interest rates to finance this larger deficit. The Federal Reserve will either increase rates slowly and allow the inflation to grow or will raise rates faster and push the economy towards much slower growth and even a mild recession. But the force of fiscal policy is formidable and it will be difficult to offset this. No one sees Trump increasing taxes or reducing expenditures. [With the most likely outcome the Democrats taking control of the House of Representatives in January there is little prospects of agreement on fiscal policy.] Essentially Trump has set out on the disastrous path of pushing the American economy hard at exactly the wrong time. The right policy would be to raise taxes on the wealthy, increase social security taxes, and to moderate government expenditures, particularly for defence. [In my opinion the defence budget has little connection with the national security of the United States, it is a feeding trough for the defence industries and fails to focus on what now really matters for national security-more investment in cyber warfare, an expanded State Department and CIA, a much larger international cultural affairs programme and expansion of the World Bank and USAID with much focus on infrastructure and tertiary education while reducing funding of anti-poverty programmes.]

3. SIGNALS OF A RECESSION COMING: All Bangladeshis understand that if you make a bank fixed deposit for 3 (three) years you expect to get a higher interest rate than for a one-year fixed deposit. The longer the period you commit your money the more interest you want. The same principle holds for bond markets in the United States. If you buy a long-term bond you expect to earn more interest per annum than for a short-term bond. Suppose one sees despite the above that the short-term bond earns more than the long-term bond, what does it mean [remember these are markets so yields are established by supply and demand]? This is a so-called "inverted yield curve." It signals investors believe that interest rates are going to be lower in the future. That basically means that investors think that a recession is coming. The recession will cause the Federal Reserve to lower interest rates. The attitude of thousands of investors is usually a very good signal of a coming recession. Indeed the yield curve for US Government securities is fast approaching inversion. Many persons interpret this as pointing to a coming recession. This expectation may well influence the Federal Reserve to go slower at raising interest rates, but then inflation may be higher.

4. TRUMP'S TRADE POLICY: Mr. Trump cannot reduce the current account deficit of the United States by increasing tariffs. The current account deficit is equal to investment minus saving. To lower investment one has to raise interest rates; to increase saving one has to reduce consumption, may be higher interest rates will help but not much. To reduce the current account deficit you have to slow the economy. Trump is doing the opposite; the Federal Reserve will raise interest rates but the impact on the current account deficit takes time. If anything Trump's macro-economic policy will increase the current account deficit. The tariffs will shift the deficits around: Raise the tariffs on China and the deficit will shift to other countries. If you raise the tariffs enough you might manage to reduce investment but increasing saving does not follow. We expect the tariffs will have little impact on the current account, until they cause an economic slowdown.

5. EXCHANGE RATE MANEUVERS: The dollar is revaluing with respect to most other major currencies. The stronger US dollar will tend to weaken the American economy and increase the current account deficit. The stronger currency reduces exports and increases imports; the higher interest rates reduce investment and increase saving. Trump can have his reduced current account deficit only by slowing the economy and encouraging a recession.

We give Trump an F in macro-economics. He is illiterate. His advisers surely know better but they love to be in high positions and so become intellectually dishonest.

WHAT DOES ALL OF THIS MEAN FOR BANGLADESH?

a. Interest rates are rising. Funds from abroad will cost more. There is less interest in emerging market capital markets. Private sector capital inflow will weaken.

b. The dollar will get stronger. If Bangladesh continues to more or less keep the Taka pegged to the dollar then the real effective exchange rate will continue to revalue, export growth will slow and import growth will rise. To stop this without adjusting the exchange rate will require the Bangladesh economy to slow down.

c. World demand for oil will weaken and there will be a drop in oil and gas prices.

d. World demand for garments will weaken possibly reducing Bangladesh exports, unless the competitive position improves.

e. The Indian rupee will devalue as capital moves out of India; this will reduce food inflation in Bangladesh. The Chinese Yuan will also devalue. Imports from both countries will increase.

f. The total impact on Bangladesh is likely to be slower growth and lower inflation.

Dr Forrest Cookson is an economist.