The fiscal policy changes enacted this year have understandably attracted a lot of attention, probably because they have given a powerful lift to corporate profits and have – separately – been quite controversial politically.
However, there is reason to suspect that a perception that that the policy changes are important may be encouraging an exaggerated sense of their impact on the business cycle and the Fed’s reaction to it.
The main point of this short report, then, is to emphasize that the Fed cannot actually be confident now that a swing toward austerity or even loss of stimulus after the middle of next year will be sufficient to deliver the aggregate slowdown that would seem to be required.
Government spending, in particular, has not yet even really accelerated, particularly relative to the overall economy. The tax side is tougher to assess, but it is worth recalling that its influence, whatever it is, is slated to dissipate, not actually reverse, even if there are no additional tax cuts legislated, which we obviously cannot exclude.