## A Shifting U.S. Policy Mix: Global Rewards and Risks

_IMF Blog, December 20, 2016_

## Source details

**Canonical URL:** [A Shifting U.S. Policy Mix: Global Rewards and Risks](https://www.imf.org/en/blogs/articles/2016/12/20/a-shifting-u-s-policy-mix-global-rewards-and-risks)

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## Bibliographic details
- Authors: Maurice Obstfeld
- Published: December 20, 2016

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### Key market developments and immediate observations
- The Fed raised interest rates for just the second time in a decade; the decision was widely anticipated by markets.
- Sharp post-election moves occurred in:
  - longer-term U.S. interest rates,
  - the dollar (which "has risen further in the days following the Fed’s recent move"),
  - market-based measures of long-term inflation expectations.
- These abrupt market reactions following the November 8 U.S. presidential and congressional elections contrasted with the absence of comparably abrupt reactions before the December 2015 rate hike.
- Timing of asset-price movements suggests the market response reflected a shift in expectations about the future interest rate path and future demand in the U.S. economy, not only the imminent December rate hike.

### Causes and expectations for U.S. monetary policy
- Longer-term nominal interest rates are strongly influenced by expectations of the future path of the Fed’s policy rate, which responds to U.S. inflation pressures and the economy’s underlying strength.
- Federal Open Market Committee members now anticipate a steepened future path of interest rates that "suggests three interest rate hikes in each of the next two years."
- The post-election shift in expectations is linked to the end of six years of divided U.S. government with the election of Donald Trump and continued Republican congressional control.

### Fiscal policy shift in the United States and domestic implications
- Congressional Republicans have long advocated lower personal and corporate tax rates; President-elect Trump campaigned on substantial tax cuts plus increases in some government spending, notably defense and infrastructure.
- Expected fiscal stance: "it will turn more expansionary through some combination of more spending and lower tax rates."
- Potential macro effects:
  - Increased U.S. aggregate demand → rise in real output and upward pressure on inflation.
  - With the unemployment rate at 4.6 percent and other labor market distress measures largely recovered, there may be "little remaining slack in the U.S. economy."
  - Unless labor force participation and overtime work rise significantly, inflation pressure could "rise noticeably."
  - Faster-receding slack and inflation concerns underpin the Fed’s expectation of more rapid rate increases.
- Additional dollar pressures:
  - Tax incentives for U.S. corporations to repatriate past profits held abroad, estimated at $2.5 trillion, could push the dollar up.
  - Faster demand growth and dollar appreciation would contribute to a widening U.S. current account deficit and "more borrowing from abroad."
  - The extent to which foreign borrowing finances a growing Federal fiscal deficit depends on the fiscal package’s design, offsets, government borrowing rates, and the economy’s growth response.
- Growth and inflation trade-offs:
  - U.S. growth will respond more strongly, with lower inflation, if infrastructure spending "is carefully designed to boost potential output," and tax measures "encourage investment, labor supply, and inclusion."

### International challenges and spillovers
- Advanced economies with currencies that depreciate against the dollar will benefit from higher U.S. growth and more competitive exchange rates; for many (struggling with below-target inflation), resultant inflationary pressure may initially be welcome.
- Risks for advanced economies:
  - Upward pressure on interest rates could pose fiscal challenges for highly indebted countries that do not sufficiently benefit from positive demand spillovers.
- Emerging market economy implications:
  - Benefits: more competitive currencies and higher U.S. demand.
  - Vulnerabilities remain for some despite improved buffers (e.g., foreign reserves), reduced currency mismatches, and better financial oversight frameworks.
  - Historical role: U.S. interest rates have been key drivers of net capital flows into emerging markets.
  - Flexible exchange rates can help rebalance international portfolios and limit reserve losses, but:
    - Rising dollar interest rates combined with domestic currency depreciation could reduce liquidity or worsen balance sheets.
    - Importance of dollar borrowing by residents and non-resident corporates raises balance-sheet and inflation risks.
  - Policymakers in emerging markets "therefore will remain vigilant."
- Trade and political economy risks:
  - If sharp exchange rate shifts and growing global imbalances follow the U.S. policy regime change, protectionist pressures become a major risk.
  - Emerging market economies are likely targets for higher trade barriers erected by advanced economies seeking to maintain manufacturing.
  - Protection is likely to be counterproductive domestically because of the integration of advanced economies into global supply chains.
  - In an environment of sharply divergent policy mixes, "the rules of the global trading system will be more important than ever."

### Policy recommendations and considerations
- For U.S. policymakers:
  - Design infrastructure spending to boost potential output.
  - Structure tax measures to encourage investment, labor supply, and inclusion.
  - Consider the implications of repatriation incentives for the dollar and external balances.
- For emerging market policymakers:
  - Maintain or strengthen policy buffers (e.g., foreign reserves) and financial oversight.
  - Use flexible exchange rates as a buffer against rapid outflows where feasible.
  - Be vigilant about balance-sheet vulnerabilities linked to dollar borrowing and potential inflation from currency depreciation.
- For advanced-economy policymakers:
  - Manage fiscal exposure to rising global interest rates, especially if highly indebted.
  - Acknowledge that protectionist measures are likely to be counterproductive given global supply-chain integration.
- For the global community:
  - Reinforce and rely on the rules of the global trading system to manage risks from divergent policy mixes.

*Source: A Shifting U.S. Policy Mix: Global Rewards and Risks — Maurice Obstfeld, December 20, 2016*

---

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## References

- [عربي](http://blog-montada.imf.org/?p=4639)
- [https://www.imf.org/wp-content/uploads/2016/12/usintrates-chart.jpg](https://www.imf.org/wp-content/uploads/2016/12/usintrates-chart.jpg)
- [secular stagnation](http://www.imf.org/external/mmedia/view.aspx?vid=5196724125001)
- [counterproductive](https://blogs.imf.org/2016/09/08/tariffs-do-more-harm-than-good-at-home/)
- [video](http://www.imf.org/external/mmedia/view.aspx?vid=5250730140001)

_Source: https://www.imf.org/en/blogs/articles/2016/12/20/a-shifting-u-s-policy-mix-global-rewards-and-risks_