Introduction
During the Presidential election campaign (2016), President Trump severely criticized the economic policy of previous administrations. He asserted that previous administrations not only signed faulty/imbalanced trade agreements, but also failed to devise an effective and balanced economic policy that could address primary economic concerns, such as economic growth, full employment and healthy inflation rate (Nelson, 2018).
President Trump also revealed that he would employ an expansionary fiscal policy to address major economic concerns and would not rely only on monetary policy to produce desired economic results. During the campaign, he discussed how he intended to “fix” the economy. For instance, Trump promised major tax-break/cut to increase the size of investment and consumption. Also, President Trump also promised massive investment in United States’ crumbling infrastructure, which would produce the desired results, such as swelling of economic growth and full employment, in the very quick period.
Trump Administration has already implemented part of its economic strategy/policy, which was based on tax cuts. Now the administration intends to implement that part of the strategy in which government expenditure increases around $1.5 trillion (regarding infrastructure spending). This increase in expenditure intends to improve the infrastructure of the United States, which in return will intensify economic activity within the United States (Long, 2018).
As per the details, of this fiscal scheme, which was provided during the State of The Union Address, Trump Administration intends to work along with the private sector, wherever and whenever possible, during the implementation of the expansionary fiscal program. However, there is a lack of details regarding the projects on which Trump Administration intends to spend money. Also, we also do not have details about the fashion in which Trump Administration intends to allocate/consume financial resources. Therefore, it would not be easy to carry out robust analysis regarding the economic scheme of spending trillions of dollars in United States’ infrastructure. However, we will be able to predict how a 1.5 trillion-dollar spending would affect the American economy (Breuninger, 2018). Our analysis would pertain to the possible effects of infrastructure spending on the current economy.
Problem Statement:
How $1.5 trillion spending on infrastructure (expansionary fiscal policy) would affect the United States’ economy in short, medium, and long terms?
Infrastructure Spending in Historical Context
Introduction of the Fiscal instrument, in capitalist economies, allowed governments to allocate/spend financial resources. After the Great Depression, of 1929, Roosevelt Administration employed fiscal policy to end economic depression. The spending on infrastructure generated employment, which increased the size of consumption. As consumption increased, so did inflation, which acted as an incentive for investors. Therefore, infrastructure spending was quite successful in intensifying economic activity.
Since then, various capitalist economies have employed an expansionary fiscal policy to realize various kinds of political-economic-social objectives. However, it is also the fact that governments, especially in developed countries, abstain from adopting an expansionary fiscal policy, as it creates various kinds of challenges, such as the large size of government and crowding-out effect. Therefore, we see that economies/countries generally/preferably rely on monetary policy to only address economic concerns, but also to realize economic objectives.
Trump Administration intends to implement expansionary fiscal policy (massive infrastructure spending) because it believes that repercussions of the 2007 financial crisis have not disappeared.
Prevailing Economic Conditions
For a robust and accurate projection regarding the possible impact of infrastructure spending on the economy, knowing the current health of the economy is a prerequisite.
Since the beginning of the 2007 financial crisis, the Federal Reserve has adopted an expansionary monetary policy, which intends to increase inflation and investment with the expansion of money supply and lowering of interest rates. For a very long period, the Federal Reserve kept interest rates low, so that it could increase the size of investment in the United States’ economy. This policy has benefited the United States as it not only increased the size of the investment but also employment and consumption. (Note: Consumption is considered an engine of economic growth).
According to Federal Reserve, the American economy is heating up, which implies that the general price level is increasing, and unemployment level is at its natural rate. In fact, the massive increase in employment/jobs, in February, did not change general employment level in the economy, which suggests that employment is at full level (Mutikani, 2018).
As the economy is heating up, the Federal Reserve intends to increase interest rates, which would curb inflation. It is quite evident that the Federal Reserve is quite sensitive regarding the probable increase in inflation, which is why it intends to employ a contractionary monetary policy. However, some economists are of the view that the economy is not at full employment and inflation is still quite low (Federal Reserve should allow it to soar) (Tankersley, 2018).
Analysis
Trump Administration intends to increase government expenditure by spending on the crumbling infrastructure of the United States. It will have an impact on different sectors of the economy. However, for this academic exercise, we will emphasize the effect of spending on employment, wages, economic growth, consumption, investment, and inflation, as these are major macroeconomic indicators.
Employment
The massive increase in government expenditure in the form of infrastructure spending will generate employment. As per most of the estimations, employment is at full level. It implies that infrastructure spending will not have any major impact on employment.
It must also be acknowledged that Trump Administration is contemplating to increase government expenditure (regarding infrastructure spending) to around $1.5 trillion (federal funding would be around 50% of total expenditure). If the multiplier effect did not increase employment level, then its impact on other aspects of the economy would be damaging.
Wage
It is apparent that the American economy is operating at full employment level (almost), there is enormous evidence regarding it. In such economic conditions, when Trump Administration would increase the size of government expenditure, unemployment would not change; however, wages (nominal) will get affected. It is because the demand for labor, as a result of infrastructure spending, will shift to the right, which will increase nominal wage in the short run. An increase in nominal wage will impact the American economy in some ways.
Consumption
Consumption is considered engine of United States’ economic growth. In fact, it is the fluctuations in consumption that cause changes in the economy (mostly). Therefore, we can say that the American economy is consumption driven and therefore, there is additional emphasis on consumption by economic/financial institutions. The injection of $1.5 trillion in the economy will have a positive impact on nominal wages. Increase in nominal wages, in the short-run and medium-term, will increase the size of 1) real income and 2) consumption. The increase in consumption will increase inflation, as there will be more demand for goods and services than previous, causing the demand curve to shift to the right.
Output
The end objective, of infrastructure spending, is to 1) improve the employment rate and 2) to intensify economic activity. It does not seem to increase the general output level. As the infrastructure spending would repair existing infrastructure, therefore, there would not be a significant increase in general output. However, it will surely intensify economic activity, which may over-heat American economy.
Investment
Trump Administration desire’s substantial role of the private sector. However, this would not be possible because of the enormous increase in expenditure by federation and the states. For instance, because of government spending on infrastructure, interest rates would increase (borrowing would increase interest rates), which would reduce demand for loans. The crowding-out effect will reduce the role of the private sector not only for this scheme but also in the overall economy. It is apparent that in the medium and long terms, because of high-interest rates, size of investment in the American economy will reduce. It may reduce abnormal as already Federal Reserve was also planning to swell interest rates.
Inflation
Inflation is one of the definite outcomes of intended infrastructure spending. We already know that in the short-run nominal wages and real income will increase because of infrastructure spending of around $1.5 trillion. As the nominal wage and real income will increase, so does the consumption, which will shift the demand, curve for products and services to the right causing an increase in the general price level.
General Price Level Graph (Self Made)
In short and medium terms, wage, real income, consumption, interest rates and inflation would increase because of almost $1.5 trillion in infrastructure spending. However, there would be a decrease in investment in the medium and long terms because of the crowding-out effect.
Conclusion
In the end, it can be concluded that Trump Administration seems quite consistent regarding its economic policy. It has already implemented the tax-cut part of its economic strategy, and now it seems determined to increase government expenditure to improve/repair crumbling infrastructure of the United States. However, the result of this expansionary fiscal policy would be mixed. For instance, it would not increase employment level, the economy is operating at almost full-employment level; however, it would increase wages, which is a serious concern since the start of the Great Recession.
Also, this fiscal activity may reduce the role of the private sector in the medium and long terms. For instance, because of the government borrowing, interests increase, which are negatively related to investment? Currently, the government intends to expand its spending, which will push the interest rates upwards, causing a decline or decrease in demand for loans from the private sector. Therefore, in the medium and long terms, this decision to repair United States’ infrastructure would hurt the economy.
References
Breuninger, K. (2018, June 30). Trump calls for $1.5 trillion infrastructure bill during State of the Union speech. Retrieved from https://www.cnbc.com/2018/01/30/trump-calls-for-1-point-5-trillion-in-infrastructure-investment.html
Long, H. (2018, March 29). Trump promised $1.5 trillion in infrastructure spending. He’s 1 percent of the way there. Retrieved from https://www.washingtonpost.com/news/wonk/wp/2018/03/29/trump-promised-1-5-trillion-in-infrastructure-spending-hes-1-percent-of-the-way-there/?utm_term=.2b5504a9ba2a
Mutikani, L. (2018, January 5). U.S. job growth cools as labor market nears full employment, wages up. Retrieved from https://www.reuters.com/article/us-usa-economy/u-s-job-growth-cools-as-labor-market-nears-full-employment-wages-up-idUSKBN1EU0EF
Nelson, L. (2018, March 3). Trump blames past presidents as far back as George H.W. Bush for economic woes. Retrieved from https://www.politico.com/story/2018/03/07/trump-us-economy-past-presidents-444076
Tankersley, J. (2018, April 26). Fed Officials Worry the Economy Is Too Good. Workers Still Feel Left Behind. Retrieved from https://www.nytimes.com/2018/04/26/us/politics/fed-economy-overheating.html
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