Market Discipline Will Probably Prevail Over Flawed US Policies

The collective power of global investors raises the hope that the Trump administration will stop acting on its worst instincts

- NOURIEL ROUBINI

Since US President Donald Trump's election last year, I have argued that at least some of his policies will lead to higher growth and lower inflation over time. This applies to his support for tech-industry innovation, deregulation, lower tax rates on labor and corporations, enhanced energy production and cuts to wasteful public spending.

President Trump's other policies, though, are stagflationary. Protectionism and tariffs will slow growth and increase prices, as will his administration's crackdown on immigration, cuts to scientific research funding, attacks on academic institutions, support for unfunded budget deficits, threats to Federal Reserve independence, disorderly attempts to weaken the dollar, attacks on the rule of law and so on. The US brand has been badly damaged, and that will have costs.

Still, I have maintained that market discipline (not least from bond vigilantes) and a still-independent Fed would constrain these stagflationary policies, giving Trump's moderate economic advisors the upper hand and leading to a de-escalation of trade frictions via negotiations. So far, that is what has happened. And now that congressional Republicans are negotiating a budget bill that will further increase deficits and debt ratios, the pressure from the market (through higher long-term bond yields) will grow. Trump can either change course or face a spike in bond yields that will cause a politically damaging recession.