Trump’s big bill will boost growth but impact muted by Fed interest rates, research shows

Audio By Carbonatix

Enlarge

By Howard Schneider

WASHINGTON (Reuters) -The Trump administration’s mammoth fiscal legislation will boost economic growth next year, but the impact will be partially undercut by Federal Reserve interest rates kept higher than they would be otherwise, a former top Fed researcher concluded in a new analysis.

The federal deficit, meanwhile, will be even larger than the gain in gross domestic product.

John Roberts, former deputy associate director of the Fed’s research division and now a special advisor to Evercore ISI, wrote in an analysis of the Trump legislation known as the “One Big Beautiful Bill” that the arrival of perhaps $100 billion in extra refunds early next year will help lift economic growth by about four-tenths of a percentage point in the first half of the year. 

The legislation exempted some overtime and tipped income from taxes and included other tax breaks. 

The GDP impact will fade fast, however, and for the full year growth will be about 0.32 percentage points higher than it would have been otherwise, Roberts found using the Fed’s internally developed and publicly available FRB/US model of the economy. Next year’s deficit, meanwhile, will grow by eight-tenths of a percentage point as a result of the tax cuts and higher spending on defense and border protection.

The slowing impact on growth is  partly due to the nature of consumer behavior – the extra money is likely to be spent quickly by the households who intend to spend it at all – and partly due to the Federal Reserve reducing its benchmark policy rate less than it would otherwise due to faster economic growth that leads to slightly higher inflation and a slightly lower unemployment rate.

“The model suggests that rates should be roughly a quarter point higher at the end of 2026 than would have been appropriate in the absence of One BBB stimulus – so for instance, one cut if two would otherwise have been warranted,” Roberts wrote. “In response to the stronger economy, interest rates are higher and those higher interest ratesdampen the increase in GDP” by about half.

Roberts’ findings illustrate the type of considerations the Fed will be debating at the December 9-10 meeting, with the implications of changed tax policy factoring into the outlook for next year. Officials already are divided over whether further rate cuts are needed now, while President Donald Trump continued to demand lower rates.

(Reporting by Howard Schneider; Editing by Hugh Lawson)