PRESIDENT BIDEN IS INAUGURATED: THE CHALLENGE BEGINS

Chief Economist's View

Download the PDF version including our economic update by region here: President Biden is inaugurated: the challenge begins. 

On Wednesday, Joe Biden was sworn in as the 46^th President of the United States and wasted no time initiating his agenda. In just a day and a half, President Biden signed executive orders recommitting the US to the Paris Climate Accord, for COVID-fighting measures including mask wearing and safe reopening of schools, and on immigration, amongst others. Of course, the first year of President Biden’s administration will be judged on how effectively COVID is dealt with. But the administration must also deal with a range of other issues including immigration, the environment, international trade and income, wealth and racial inequality.

His $1.9 trillion American Rescue Plan fiscal package is President Biden’s main policy instrument in the fight against COVID. The package represents around 9% of US GDP and follows fiscal packages of around $3.2 trillion or 15% of GDP over 2020, with the latest being around $900 billion in December. The big ticket items in the Biden package are income support to low and middle income earners in the form of a $1400 cash handout and an extension and boost to unemployment insurance. These two items account for almost 40% of the total package.

The other large ticket items are additional funding to State and Local govts, particularly for health, funds for a national vaccination and testing program and funds for schools and child care. These account for around a quarter of the package. The stimulus is focused heavily on income support to households as most packages around the world have done, including here in Australia. As such, it will boost US consumer spending on US-produced goods and services and imports, and it’s through international trade that the stimulus will flow to the rest of the world.

The response of financial markets to the package may be somewhat tricky to predict. The lift to US and global growth should be a positive for risk assets, but the potential for higher inflation could dampen market expectations on the extent of central bank liquidity measures. This opens the prospect of higher interest rates, which would be a negative for risk assets and there is also the possibility of a weaker US dollar, which dampens the positive impact of US spending on goods and services from the rest of the world as their currencies appreciate. Finally, there remains the issue of a hike in the corporate tax rate, not included in the budget, which would reverse the boost to equity markets that we saw back in 2017 when the Trump administration lowered the rate.

But can President Biden and the Democrats even implement the package? The sticking point is that all legislation relating to budgets (spending, revenue and debt) must pass through Congress and it must gain 60% of the Senate votes to avoid the Filibuster and to pass into law. This means that to pass the budget, 10 Republican senators would have to vote in favour and all of the Democrat senators would have to vote in favour. That’s a high hurdle given the current partisan nature of US politics and the fact that many big-spending policies, including the intended boost to the minimum wage would not sit well with many moderate Democrat senators, let alone the Republican senators.

However, if President Biden does fail to muster 60% of Senate votes, he can fall back to the process known as reconciliation. But this option is not without its own set of difficulties. Only 51 Senate votes are required to pass reconciliation bills (which can be achieved with the Vice President’s tie breaker vote) following the passage of a budget resolution. However, there are limits on what can be included via reconciliation (to spending, revenue and debt limit), so some policies would likely need to be dropped (e.g., the minimum wage hike and potentially some of the funding support to State and Local govts) and the process typically takes a considerable amount of time to implement.

Also, only one bill on spending, revenue and debt can be passed each year, so Democrats may want to add other priorities if it pursues the implementation via reconciliation, which would delay further the passage of the American Rescue Plan. At this stage it remains unclear how the package will pass Congress, however, under either approach we would expect a more watered-down version of the stimulus package (either to gain Republican support or via exclusions and amendments under reconciliation). Our current view is that slightly more than half the package will ultimately survive, or around $1.1 trillion, which would lower the size of the package from 9% of GDP to around 5%. That’s still a very sizeable boost to demand and we estimate that it will lift US GDP growth from around 3.7% to just over 5% in 2021.

We are confident that with the budget measures in place (even watered down) and with a better COVID vaccination plan in place, the US economy can stage a swift comeback, but we are not confident that these alone will make America great again. President Biden’s challenge is to prevent the inward-looking/us-vs-them politics of the MAGA movement from putting down even deeper roots in US society. President Biden faces an enormous challenge in turning the tide, remembering that over 70 million Americans voted for Donald Trump.

Notwithstanding the challenges, the US under President Biden stands the best chance of galvanising democratic countries across both politics and economics. This means re-engagement of the US with its traditional allies across issues to do with trade, the environment, immigration and economic and racial equality. Can President Biden sell this outward refocus to the American people at the same time as stemming the growing polarisation within US society? Let’s hope so.

Table 1: Financial market movements: 14 - 21 January 2021

Source: Bloomberg