Changes in federal economic policy could be on the horizon, but such policy will likely be slow to have an impact on the U.S. economy. University of Michigan economist Gabriel Ehrlich says he’s optimistic that the economy still has room to grow.

Ehrlich is the associate director of U-M’s Research Seminar in Quantitative Economics. Previously, Ehrlich worked in the financial analysis division at the Congressional Budget Office, where he forecast interest rates and conducted analysis on monetary policy and the mortgage finance system. His academic research focuses on several areas of housing and land economics as well as the effects of wage rigidity on labor market outcomes.

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Q: We may see a number of federal policy changes in 2017 and 2018 with
President-elect Trump. Trade is just one area, but tax cuts and reduced business regulation could all come into play. How might these types of changes impact your U.S. forecast?

Ehrlich: The first thing to keep in mind is that federal policy changes tend to happen more slowly than one might expect. So, many of the policy changes enacted by the incoming administration are likely to affect the economy only gradually, and in some cases not until after 2018.

That said, even expectations of policy changes in the future can affect economic conditions today. For instance, the possibility of larger budget deficits, resulting from tax cuts and increased spending, has pushed up interest rates on Treasury securities. The interest rate on 10-year Treasury securities rose from 1.83 percent on Nov. 1, before the election, to 2.47 percent on Dec. 9. Those higher interest rates will feed into other sectors of the economy, for instance by leading to higher interest rates on mortgages and auto loans.

It appears reasonable to expect reduced business regulation in many sectors of the economy, although it is too early to have much confidence in the details at this point. Business regulation is an area in which the effects on the economy are likely to be felt relatively slowly.

Q: The U-M forecast anticipates that the Fed will raise interest rates by 50 basis points each year through 2018. How might that impact the still-recovering existing housing market and the new home market?

Ehrlich: Although we expect the Fed to proceed with its monetary tightening cycle over the next two years, it is important to emphasize that the pace of interest rate increases we envision is slow relative to the pace during many previous rounds of monetary tightening. Therefore, we expect monetary policy to remain supportive of growth, including in the housing market, through 2018.

The behavior of long-term interest rates, which as noted above have increased sharply since the election, poses a larger risk to the recovery in the housing market. Even so, it is important to remember that interest rates are still very low relative to historical averages, so any damage to the housing recovery should be minor.

Q: Are you concerned about the possibility of a recession beginning sometime in the next two years given that the current economic expansion began in 2009?

Ehrlich: There is always a concern during an economic expansion that another recession could be lurking around the corner. Economic expansions do not die of old age, however. Rather, there is often a policy error, such as too much monetary tightening, or an external shock to the economy, such as an energy or financial crisis, that tips the economy into recession.

We are actually optimistic that the current economic expansion has a good deal of room left to run. The housing market still has room to expand, financial conditions are supportive of growth, and the labor market is still not at full employment in our judgment. Fiscal policy is also likely to become more stimulative over the next few years.

The major risks to our optimistic view are the possibility of the Federal Reserve tightening monetary policy too quickly, a major trade war breaking out, or renewed fears of a financial crisis in Europe or Asia.

More information:

• University of Michigan economic forecasts