After near total collapse during the Great Recession of 2007-08, the American economy has steadily improved. Rising employment and GDP under the Obama administration continues under the Trump administration — for now. Financial markets, steadily rising under the Obama administration, climbed a bit more, and reached a peak under the Trump administration. 

The Fed’s decade-long expansionary monetary policy and modestly expansionary fiscal policy under the Obama administration are major reasons for this progress. Expansionary fiscal policy under the Trump administration further boosted the economy but creates real risks down the road.

The Dodd-Frank bill signed under the Obama administration, aimed at curbing financial hi-jinx, restored some confidence in the nation’s banking system. Republicans, never fond of Dodd-Frank, are talking of its repeal. That’s folly, an invitation for big banks to repeat their malfeasance.

Aside from repeal of Dodd-Frank, with low unemployment, healthy corporate profits, and near record stock prices, what could possibly go wrong? A lot of things.

First, what not to worry about. The Fed acted correctly in keeping short term interest rates at historic lows during recovery from the Bush recession. Fed Chair Janet Yellen was clear about not raising rates until the economy approached the Fed’s target of about a 2 percent annual inflation rate. Every time the Fed was feared to raise short-term rates a quarter percent, money managers went into a near tizzy. 

Modest rate increases consistent with an expanding economy should pose no barrier to growth or financial markets. That is simply responsible monetary policy. In addition, higher interest rates will give the Fed some arrows in its quiver, so to speak, should lower interest rates be required during a future recession.

The greater worry regarding future interest rates is related to the expansionary fiscal policy recently enacted by Congress. Huge tax cuts, along with huge increases in government spending in a fully employed economy, risks overheating the economy. This threatens to bring inflation to levels above two percent, forcing the Fed to raise interest rates to levels that could indeed curb economic growth.

It was once a Republican article of faith to oppose government deficit spending. But that is obviously no longer the case as long as deficits are incurred to award tax huge tax cuts to big financial donors.

In the event of the next recession, high public debt curbs the ability of the president and the congress to use the powerful weapon of fiscal policy to get out of recession. This leaves only the Fed’s monetary to deal with it.

In other words, the Fed juggles its usual balancing act, keeping interest rates low enough to encourage economic growth, but high enough to keep the economy from overheating. With overly expansionary fiscal policy in a fully employed economy, the task of economic stabilization is left solely to the Fed with its limited policy tools.

The Fed’s low short-term interest rates contributed to steadily rising financial markets. Low returns on bonds made stock dividends relatively attractive, stimulating demand, hence price, of stocks. As long as interest rates rise in line with an expanding economy, that should pose no problem. But if the Fed is forced to raise interest rates rapidly to curb inflation, that could indeed put a crimp on financial markets.

Another worry, not just on the horizon, but upon us, is threat of a trade war with our major trading partners, including Canada, Mexico, China and the European Union. Economists and all involved in commerce agree that international trade, through the principle of comparative advantage, leads to more efficient use of the world’s resources and, hence, lower consumer prices in the aggregate. In the long run, everybody is “better off.”

The catch here is the two words, “long run.” As the great 20th century economist, John Maynard Keynes, reminded us, “We’re all dead in the long run.” In the short run, some businesses and labor are hurt. Thus, the incentive for protection of those industries from foreign competition. Another ostensible reason for protectionism is the “international security” argument currently touted by President Trump. 

Protective measures include tariffs, taxes on imports that raise their price. Other protective measures include non-tariff barriers such as quotas, and standards dealing with quality and health. While some standards are legitimate, others are clearly designed to keep foreign products out, thus protecting domestic industries.

Steel and aluminum workers favor tariffs on those products. But producers of products using steel and aluminum bear increased costs through rising prices of their inputs. While the impact of those tariffs on the overall economy would possibly be tolerable, it is the reaction of other nations to these and additional tariffs proposed by Trump on a range of goods that is the greater worry. Strategically placed foreign tariffs on American soybeans, Harley-Davidson motorcycles and Kentucky bourbon will hit America where it hurts.

Whether Trump’s use of tariffs as a “negotiating strategy” succeeds in a better deal for America, or leads to a trade war, remains to be seen. A worst-case scenario is a trade war, a faltering economy and tanking financial markets. 

What is curiously lacking in international trade negotiations are the prospects of raising wages for foreign workers, particularly those of China, Mexico and other low wage countries. Rising wages for these workers would be a win for all, including for American labor.

Rising wages in competing countries would benefit American workers through making American labor and industries more competitive. It would clearly be a win for foreign labor through increasing their purchasing power. Imagine the worldwide increase in aggregate demand if wages of underpaid workers throughout the world would rise by even a modest percentage. 

This would be a win for the entire world economy. It’s hard to think of a greater boost to the world economy than to increase purchasing power of millions of low-wage workers.

Next week: Structural threats to the economy.

— John Waelti of Monroe, a retired professor of economics, can be reached at jjwaelti1@tds.net. His column appears Wednesdays in the Monroe Times.