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Republicans sweep the House and Senate - a red fireball approaching?
The US Presidential results are in and Donald Trump and the Republicans have been swept into power in an electoral outcome few had envisaged. Control of both the House of Representatives (with only 7 of the remaining 25 undecided seats needed) and the Senate by the Republicans opens the door to President-elect Trump to ram through his ambitious policy agenda, which includes: mass deportation of undocumented migrants; generationally high tariff rates and a US$7.2 trillion budget hit composed mainly of tax cuts to households and businesses. Can Mr Trump really get his policies implemented without them being held up by the Democrats? His tax and spending policies (and any changes to the debt ceiling – which his fiscal policies will certainly blow through) require that they pass the House and the Senate.
Although the Republicans will hold majorities in both chambers, they do not have the “super majority” of 60% of the seats (i.e., 60 seats) in the Senate required to pass fiscal legislation. However, they can revert to the process of Reconciliation to pass budget and fiscal legislation with the requirement to achieve a simple, rather than 60% super majority. Turning to tariffs, the President can enact legislation unilaterally according to section 232 of the Trade Expansion Act on “…imports that pose a threat to national security.” Apart from Mr Trump’s tariff hikes in 2018-19, this section has been frequently used by Executive, including the Kennedy Administration that signed the act into law in 1962. Lastly, through their control over law enforcement agencies, US Presidents have the power to deport undocumented (i.e., illegal) immigrants and to control the border flow of undocumented immigrants.
Therefore, in theory, Mr Trump could enact the entirety of his policy program. So, what does this program look like? He proposes to deport 11 million undocumented migrants. That’s 3% of the US population and a higher percentage of the working population and labour force. A loss of workers of that order of magnitude would create a significant labour shortage, drive up wages and inflation and lower economic activity, which we estimate would lower US GDP by 3 percentage points (ppts) by the end of his term in office. He proposes to raise tariffs on Chinese imports to 60% and to 10% on all other imports. Our estimates suggest this would drive the annual rate inflation up by 2.5ppts by this time next year.
The primary budget impact of his fiscal policies would be to increase public debt by US$7.2 trillion, US$5 trillion more than that proposed by Harris and that which is embedded in the current Biden budget. If we sum up the impacts of fiscal policy, tariffs and immigration, where would that leave the US economy? Our simulations using the NiGEM model suggest the combined Trump policy package would lead to a stagflationary macroeconomic environment. Results indicate that the US economy would slide into recession in the second half of 2026, lasting into the first half of 2027.
Inflation would peak at 7% by the March quarter of 2026 and the US Federal Reserve would need to lift the fed funds rate to 6.25% by the Sept quarter of 2026 to cap inflation at 7%. Fortunately, this scenario is unlikely to play out. Partly because if it were attempted, the Republicans would lose control of the House and Senate at the mid-term Congressional elections and partly because the implementation is impractical (for example the deportation of large numbers of undocumented immigrants is impossible give the current size and any feasible increase to the agency responsible for immigration, the U.S. Immigration and Customs Enforcement).
Therefore, a watered-down version of Mr Trump’s policies is the most likely outcome, just as it was in his first term. What about the Australian economy in the “full throttle” scenario? While we don’t endure the hit taken by the US we still suffer from the slower growth in China as the tariffs hike hits their economy and slower growth across the globe more generally. Australia might avoid a recession because, just as the impact of Trumps policies hit our shores around second half of next year, our economy should be in the middle of a recovery to trend growth.
Unfortunately, that trend-growth recovery would be snuffed out and we’d be back to a below trend, sub 2%, annual growth rate from the September quarter of 2025 through to the September quarter of 2026. We would inherit higher import prices from our global trade partners and a weaker AUD. Inflation would be driven back to around 5% by the end of next year. Even that rise in inflation is limited by an increase in the cash rate to 6% by the RBA by the second half of second half of next year.
But as previously mentioned, we don’t think the full force of Trump’s policies will be enacted, so these outturns are more at the dramatically bad end of the range. The timing of policy implementation is also important. Tax cuts, and corporate tax cuts are growth and market friendly. If these are implemented swiftly (unlikely due to hold ups in Congress) then we could see a favourable economic response initially.
If tariffs are moderated sharply, then the most negative of policies for economic growth will be dramatically reduced. Finally, progress on immigration will be slow, just as every administration including Trump’s in his first term, have found.
A Trump administration promises change. Its policies, taken at face value, add weight to that promise. If delivered in full, we expect higher inflation, higher interest rates and weaker growth. Full implementation is unlikely, however, and more probable policy settings are still likely to produce a higher inflation and interest rate environment, with the impact on growth ambiguous.