Higher fiscal spending could prompt faster tightening of monetary policy says Federal Reserve's Brainard

Jasper Jolly
Follow Jasper
Inflationary fiscal spending could spur tighter monetary policy says Lael Brainard (Source: Getty)

Donald Trump’s economic policy could lead to a faster pace of monetary policy tightening, according to an influential member of the US Federal Reserve’s rate-setting body.

If the US President-elect’s policies lead to higher inflation at a time when the US is approaching full employment, the Federal Open Market Committee (FOMC) could be forced to raise interest rates to combat rising prices, according to FOMC member, Lael Brainard.

In a speech at the Washington-based Brookings Institution, she said: “If fiscal policy changes lead to a more rapid elimination of slack [in the labour market], policy adjustment would, all else being equal, likely be more rapid than otherwise.”

Read more: Fed minutes: US interest rates could rise higher than expected this year

However, Brainard also noted the “substantial uncertainty” surrounding Trump’s economic plans.

Trump has repeatedly promised to implement an infrastructure spending programme of over one trillion dollars, allied to tax cuts which could boost demand.

However, Brainard said the “additional fiscal demand will more likely result in inflationary pressures” rather than sustainable growth if it is not targeted to boosting business and households who will invest and boost productivity rather than saving.

While Trump has portrayed a US economy struggling on the global stage, the world’s biggest economy has ended the Obama era on a high, with an unemployment rate at its lowest since the financial crisis, and approaching what economists call full employment.

Read more: The Obama jobs story in four graphs

Full employment is reached when the labour force is working at full efficiency. However, it does not take into account those who have dropped out of the labour force. Trump has placed a significant emphasis on the US’s low labour force participation rate in his campaign literature.

She said: "A gradual approach will remain appropriate as long as inflationary pressures remain muted, the economy remains short of our objectives, the neutral rate remains low, and downside risks from abroad remain, although this will depend on the fiscal trajectory, as it evolves, and its uncertain effects on the economy and financial markets."

Domestic risks to the US economy are “closer to being balanced than they have been for some time,” Brainard said. However, external risks are “still tilted to the downside”, she said, with ultra-loose policy in Japan and Europe meaning there is little room for manoeuvre in the case of a downturn.

Related articles