Fed Trumps Trump: Bush-Era Fed Governor Sees Economic Growth Independent Of Trump’s Policies
Few experts on capital markets and the economy have the pedigree of Randall Kroszner, a professor of economics and former governor of the Federal Reserve Board during the Bush administration. Kroszner said President Donald Trump's proposed bold reforms and infrastructure investment have resonated strongly with both business people and consumers. But he does not believe we will see real impact until 2018 or 2019; until then, confidence is coming from the Fed.
"The post-election positive animal spirits are making people very optimistic but the impact on the economy will depend on the actual policy reforms.” Kroszner, the Norman R. Bobbins Professor of Economics at the University of Chicago's Booth School of Business, said.
We asked the former Fed governor about where he sees Trump's economic policies taking the economy and what the Fed will have to do to keep the country's economic recovery moving forward.
Bisnow: On a macro level, what are your observations of the Trump administration’s effect on the economy, this early into his presidency?
Randall Kroszner: There has been an increased optimism about the economy in 2017 and 2018, on the part of CEOs and CFOs, in nearly every survey where their opinions are asked.
Despite the confidence, most businesses have not marked up their growth path, because we don’t know the specifics to the president’s plans. There have been some things Trump has done that were encouraging, like his executive orders on regulatory reform. What is really driving investor confidence is seeing the Fed — independent of Trump’s policies — moving forward with interest rate hikes because the economy is growing more solid.
Bisnow: What has been the most surprising effect of the Fed’s actions so far?
Kroszner: It’s interesting that the 10-year Treasury rate declined; I call it a “dovish hike.” The markets fully anticipated the Fed to raise interest rates, but the key for real estate borrowing is what happens to long-term rates. I feel that some observers expected a faster rate hike, but the Fed kept the word “gradual” in their announcement, which has some elements of the conundrum Alan Greenspan dealt with in the early 2000s ... The Fed doesn't want long-term rates to increase 75-100 bps just because of a change in wording. The Fed wants no sharp movements because there’s a feeling that the economy, while it is stronger, isn’t strong enough to handle a bigger hike.
Bisnow: What have you identified as the key indicators of the economy’s overall strength and future?
Kroszner: I feel that a laser focus on wage pressures in the labor market, inflation and inflation expectations will determine how fast the Fed moves on future rate hikes. It was clear in their statement that they viewed a 2% goal for inflation as symmetric. They don’t want to be behind the curve and they don’t plan on running the economy hot for a while, because they don’t want people to expect high inflation. How the growth of the economy proceeds will determine their future moves on inflation.
Bisnow: But the president is selling 3% GDP growth, which most forecasters believe will be near impossible to hit. What is your take on GDP growth in the Trump era?
Kroszner: The key to that is what’s driving higher growth. If growth is being driven by productivity and capital allocation due to tax and regulatory efficiencies, the Fed doesn’t need to move. We saw a similar economic situation in the late ‘90s. If the source of growth is government spending not focused on reducing bottlenecks and improving productivity, then the Fed will respond faster because the growth is tied more to inflation than greater sustainable economic activity.
Bisnow: The Fed spent much of 2016 pressuring banks to tighten lending, because there were signs of overextension. Do you see that loosening in the near future?
Kroszner: We don’t have an answer from Trump on that yet. We need to see who the key regulatory appointments are before we have that answer. Keep in mind also, there are broad principles in his regulatory EOs that can be agreed upon by both sides, but the devil is in the details. Legislation will be slow. It will be hard for Congress to pass regulatory and tax reform, on top of what else they have on their agenda. So the administration will be more reliant on departments until that happens. The impact will more likely be felt in 2018 and 2019.
Bisnow: What effect do you see Trump’s agenda having on Chicago real estate?
Kroszner: On a local level, there’s a greater feeling of uncertainty related to local and state issues. Both Chicago and Cook County have daunting fiscal challenges, and the budget impasse in Springfield has no clear resolution. One area that needs reform is the pension system — that hangs over the city, county and state. Illinois has the lowest bond rating in the U.S. and when companies and individuals think of relocating here, the hesitancy to pay higher taxes to address underfunded pensions and unpaid bills weighs heavily on Chicago real estate. If we can make some progress and have some clarity that there is a path to get our fiscal house in order. Right now, they’re thick because of a lack of progress.
Bisnow: Chicago is an attractive real estate market for investors because prices remain low, compared to the coasts. Can this continue, despite real estate taxes rising?
Kroszner: The real estate prices are certainly one of the most attractive features. But investors will eventually look at those prices, how their taxes are projected to increase and how that will affect their expected returns. If the fiscal issues continue and increase the tax burden, that will weigh on people’s willingness to make a commitment.
Bisnow: Another issue facing the state is labor negotiations. Gov. Bruce Rauner said he would not be returning to the bargaining table with the public workers’ main union, stoking fears of a possible strike. Do you see either side willing to concede some things to improve the state’s fiscal health?
Kroszner: In labor negotiations, one always enters with strong demands. Future negotiations will be tough because both sides have tough demands that they’ve shown an unwillingness to budge.
Bisnow: What common ground do Rauner and the Democratic-held General Assembly need to reach to move forward?
Kroszner: Both need to realize that Illinois is losing population, not only to neighboring states, but to healthier fiscal markets nationwide. Other states are making progress in rapid job and population growth, at Illinois’ expense. Until lawmakers recognize the severity of the problem, they won’t budge. It may take a clear shock to get them to realize the severity of the situation. We want to avoid a Detroit-like death spiral — and I want to stress that we aren’t there — but lawmakers need to understand how easy it is to go down that path if they don’t make the right decisions.
Randall Kroszner is the keynote speaker for Bisnow's 8th Annual Chicago Capital Markets: The Trump Era event, 7 a.m. Wednesday, April 12, at the Loews Hotel Chicago. Register here.