Janet Yellen’s final meeting as chairwoman of the Federal Reserve this week will be marked by a serious debate about the Trump tax cuts, as officials sort out whether and when the overhaul will increase economic growth.
The tax bill hadn’t been finalized at the time of the Fed’s last meeting in December, and its signing is the biggest change to the economic outlook. Fed members were debating the effects of the potential overhaul then.
Apart from addressing the tax cuts, much of the Fed’s major business has been set for the next few months. Yellen is set to hand over a Fed to Trump appointee Jerome Powell that is, in many ways, now on autopilot.
Under Yellen, the central bank has begun raising interest rates without causing a market panic and has conditioned investors to expect several more rate hikes this year. It also has seamlessly begun shrinking its balance sheet, swollen from crisis-era bond purchases.
The economics of taxes is one of the biggest challenges facing the Fed now, as officials gather in Washington for a two-day monetary policy meeting.
“Behind the scenes, there will be a lot going on at this meeting, more than just Janet Yellen getting a victory lap,” said Kathy Bostjancic, an economist for Oxford Economics, a forecasting and advisory firm. “There will be a real intense focus on what is the impact of tax cuts.”
The Fed has to wrestle with aspects of the tax cuts that Congress and President Trump did not.
In the short term, most Fed officials agree, the tax cuts will mean more money for families and businesses to spend, entailing a stimulus for the economy and boosting growth. In that way, the tax cuts work the same way as a stimulus government spending program would.
The question then is whether the tax cut stimulus is likely to boost spending enough to drive inflation higher if the Fed doesn’t raise rates faster than currently planned.
It’s possible that Yellen and company could say, when they release the monetary policy decision Wednesday, that the tax cuts are already taking effect, based on the holiday consumer spending and business investment, said Bostjancic. That would be a sign to markets that more rate hikes are coming sooner rather than later.
But that’s just the beginning of the debate for the Fed. They also have to discern whether, aside from providing a short-term stimulus, the tax overhaul will actually make the economy more efficient and boost its long-term productivity, apart from this particular business cycle.
Trump and congressional Republicans have argued all along that it will increase productivity by bringing back jobs and research from overseas and allow companies to invest more in research and improvements.
As a group, Fed officials are still debating that.
“I think the Fed’s still trying to decide what the long-term impact’s going to be,” said Scott Anderson, chief economist for the Bank of the West.
For his part, Powell gave the same line at his confirmation hearing that Yellen has also deployed with respect to the tax overhaul: He said that tax reform could increase productivity, but that it wasn’t possible to say whether the specific bill the GOP was developing would do so.
In the months ahead, he and other Fed officials will have to sort through the incoming economic data to see what the reality is. There are “lots of open questions there,” said Gus Faucher, chief economist for the PNC Financial Services Group.
Powell won’t chair the monetary policy committee meeting for the first time until its March meeting. But the committee will feature new faces Tuesday and Wednesday, because of regional bank presidents rotating into voting positions.
