Heightened policy uncertainty about international trade is weighing on activity and investment decisions. Exporters have been hit by retaliatory measures and consumers are facing higher prices due to the tariff increases. Measures to reduce trade tensions and accompanying uncertainty, such as reaching agreement with China, would help bring forward investment from firms currently waiting before committing. The projections assume that trade measures remain unchanged after the introduction of the new tariff measures already announced for December. On that basis, increased US tariffs and associated retaliation may reduce US GDP by ½ percentage point by 2021.
Monetary policy has faced communication challenges as uncertainty about the outlook has increased and criticism of monetary policy has become more voluble. Given low inflation expectations monetary policy needs to ensure that the inflation target is met symmetrically. The Federal Reserve has undertaken three interest rate cuts as the international outlook deteriorated and as uncertainty has risen. If growth falters significantly, monetary policy may need to augment interest rate cuts with extended forward guidance and additional balance sheet operations. On the other hand, if economic conditions prove to be stronger than anticipated, a resumption of monetary policy normalisation would be appropriate.
The government is running substantial budget deficits, which are projected to rise to nearly 7% of GDP in 2021. To the extent possible, federal, state and local governments should reorient spending to areas such as infrastructure that would support productivity in the longer run. However, fiscal policy is unsustainable if sizeable deficits continue and long-term fiscal spending pressures mount. This leaves limited room for the federal government to react in the event of a sizeable downturn. Rebuilding fiscal buffers and preparing contingency plans would help prepare for possible shocks.
Part of the projected slowdown is structural, driven by demographic pressures leading to lower labour force growth. Some evidence is showing that strong job growth has drawn in workers who have tended to remain on the margins of the labour market. In addition, efforts to reduce opioid addiction appear to be bearing fruit, which will likely reduce death rates and support higher labour force participation. Continuing to help individuals back to the labour market and into jobs would help offset some of the employment slowdown while at the same time boosting productivity. Easing occupational licensing requirement and zoning restrictions would help workers find more productive jobs. These effects would help boost household incomes and help many low-income families.
