U.S. Tax Reform Expected to Boost Growth, if the Fed Gets it Right

Estimated reading time: 1 minute

Stronger consumer spending and a boost to labor productivity via increased business equipment investment is expected to spur 2.7% real GDP growth in 2018, according to the Fannie Mae Economic and Strategic Research Group's January 2018 Economic and Housing Outlook. Complementary policy decisions from the Fed are key to continued expansion, however, as the possibility of overly aggressive monetary tightening intended to preempt rising inflation could pose downside risk. This delicate balance is reflected in the ESR Group's 2018 theme: "Fiscal Policy and the Fed: Stimulus/Response." An already-low unemployment rate is forecasted to fall even further, averaging 3.7% in the second half of 2019, which would be the lowest level in 50 years. The ESR Group expects that accelerating wage growth will lead to an uptick in the labor participation rate among prime-age workers. Inflation should remain below the Fed's two-percent target this year, owing to the increased labor supply and productivity growth that would help offset rising worker compensation. The ESR Group expects the Fed to raise interest rates two times in 2018, with a third hike possible if evidence of increased inflationary pressure materializes.

"The recently passed tax bill should provide a shot in the arm for an expansion that, while long in the tooth, likely brought the best full-year performance during 2017 in three years. The question for 2018 is less about the impacts of the tax cuts for consumers and corporations than about how the Fed manages the pace of monetary policy normalization amid a stimulative fiscal environment," said Fannie Mae Chief Economist Doug Duncan. "As we see it, the traditional view of a tradeoff between employment and inflation lacks solid empirical support in recent decades, and aggressive monetary policy to ward off a potentially overheating economy may do more harm than good. Managing a 'soft landing' will be a difficult but critical task for policymakers in 2018. Additionally, the new tax laws are likely to motivate a mixed response in the housing market: increased disposable household income should lead to greater housing demand, but changes to deductions essentially reduce the subsidy for homeownership. On the whole, we expect the housing market in 2018 to encounter many of the same challenges as last year, including inventory shortages, particularly in the middle- and lower-end of the market, and affordability headwinds."