Joe Biden lives up to its reputation. Unlike Donald Trump, America’s upcoming president names seasoned candidates for the most important offices in his administration. For example, the former central bank chief Janet Yellen is to become the new “Secretary of the Treasury”, as the Treasury Secretary is called in the USA. Both Yellen and the designated Foreign Minister Antony Blinken know from their own experience in high state offices to appreciate the value of international cooperation. This is very good news after the shocks from Trump’s tenure, which plunged international trade and thus Europe’s export-dependent economy into a deep crisis before the pandemic. This is one of the reasons why the traffic lights in Germany and Europe are green for the coming year.
But what conclusions can we draw from Biden’s first personnel decisions about economic and financial policy in the USA in the coming years?
Yellen does not represent the left wing of the Democrats. She is a brilliant and reliable economist who is also married to a Nobel Prize winner in the field. She has a very thorough understanding of the US job market and its often impressive dynamics. It will indeed pursue a policy with a thoroughly social democratic touch by European standards. But excessive tax hikes, which the presumably still divided Congress would not pass anyway, are not to be expected from her. She would also not support a growth-damaging flood of regulations.
At the head of the US Federal Reserve, Yellen was rightly considered a dove. In view of the low inflation rates, she usually pleaded for a loose monetary policy when in doubt. At the same time, it has repeatedly spoken out in favor of fiscal policy doing even more to strengthen overall economic demand in the event of economic downturns. She has nothing to do with a debt brake based on the German model. The state debt ratio in the US, which under Donald Trump jumped from 100 percent of economic output in 2016 to just under 130 percent, will hardly fall under Yellen either.
A new stimulus package
Yellen’s first practical test should be to negotiate another economic stimulus package with Congress. There is a good chance that, thanks to her experience, expertise and commitment, she will succeed. However, Senate Republicans, who will likely need some votes, are likely to work to ensure that the package is closer to $ 1 trillion over ten years than the Democrats’ target of over $ 2 trillion. These are very large sums of money. But converted to a single year like 2021, the exact scope of the new package for the US economy is likely to make a difference of no more than half a percentage point in growth.
Europe would also benefit from even stronger US demand with a larger fiscal package. For us, however, the difference would, at best, be 0.1 percentage point of our economic output. From the perspective of Europe and world markets, the prospect of a calmer trade policy is far more important than the exact strength of the US fiscal stimulus.
In contrast to the economic stimulus program, there is a broad consensus across party lines in the USA: the country must invest significantly more in its infrastructure. When the by-elections to the Senate in Georgia state are over on January 5th, the mutual blockade of the political camps should ease on at least this issue. The argument that the other side does not want to grant success shortly before an important election will then no longer be valid, at least for the year 2021. It is therefore to be expected that after some negotiations on the details, Congress will approve a proposal by Yellen to significantly increase expenditure on infrastructure.
Active fiscal policy, soft monetary policy
Better taxation of the almost monopoly-like profits of the US internet giants and a coordinated approach to climate protection are among the concerns of Europe that, unlike their predecessors named by Trump, should meet with open ears at Yellen. A border adjustment charge for imports containing CO2, so that companies cannot avoid a higher domestic price for CO2 emissions by relocating production to other locations, would be an ambitious but at least not hopeless project with Yellen.
Yellen is likely to agree with her Trump-appointed successor at the helm of the US Federal Reserve, Jerome Powell, on two important points: Both are in favor of an active fiscal policy and the softest possible monetary policy that energetically supports the economy until it is socially disadvantaged Groups have found their way back into the labor market. Yellen will certainly encourage the Fed to allow inflation to rise above the target of two percent actually intended for some time.
The combination of a loose fiscal and monetary policy harbors some inflation risks in the long run, which the central bank will then have to counter – perhaps in two to three years – by shifting towards a somewhat tougher policy. But first, politics will push the economy. If, contrary to expectations, a new crisis should break out in the coming years, it should be easy for the crisis-proven Yellen to react quickly and correctly. That too is reassuring for the US and the world.
Weaker dollar, stronger euro
There are signs of good growth with very low interest rates in the coming years. In this environment, investors will be happy to take some risks. We therefore expect that capital from the safe haven dollar will flow into other currencies. Even if this should primarily benefit the currencies of some emerging countries, an outflow of funds from the dollar will probably also be reflected in a lower exchange rate of the dollar to the euro.
As Treasury Secretary to President Biden, who cares about jobs in the US, Yellen is unlikely to mind this side effect of US finance and monetary policy. In view of the great advantages that Biden’s return to partnership with Europe and other traditional US allies is likely to bring with it, the euro zone should not perceive a somewhat stronger euro, which could well have reached 1.25 against the US dollar, as a burden .
Holger Schmieding is chief economist at Berenberg Bank. He writes here regularly on macroeconomic topics. You can find more columns by Holger Schmieding here