13 November 2016

Global Economics Analyst

Global Economic Implications of the Trump Agenda

(Fawcett/Stehn)
n

Following Donald Trumps victory in the US presidential election, the focus now
turns to the potential economic implications of his proposed policies. The
November 12 US Economics Analyst used the Fed staffs FRB/US model to
analyse the consequences for the US economy. In todays companion piece, we
assess the potential global economic spillovers from the Trump agenda using our
global macro model.

Jan Hatzius

Following the US simulations, we analyse four of Mr. Trumps policy proposals,

Karen Reichgott

including fiscal stimulus, trade tariffs, restrictive immigration policies and a

hawkish tilt in Fed policy. We first analyse the policies individually and then
combine them into possible packages, including our own assumed policy
outcomes.
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(212) 902-0394 | jan.hatzius@gs.com

Goldman, Sachs & Co.

Jari Stehn
+44(20)7774-8061 | jari.stehn@gs.com
Goldman Sachs International

Nicholas Fawcett
+44(20)7051-8321 |
nicholas.fawcett@gs.com
Goldman Sachs International

(212) 855-6006 | karen.reichgott@gs.com

Goldman, Sachs & Co.

Fiscal stimulus has positive global spillovers, as stronger US demand boosts

imports for foreign goods and services. Dollar strength reinforces the positive
spillovers to DM economies with floating exchange rates, but limits the gains in
EM economies. The spillovers to China, for example, depend on the extent to
which the Renminbi appreciates with the dollar and the net effects are less
positive for EM economies that rely heavily on dollar-denominated debt.
The other components of Mr. Trumps agenda (trade policies, immigration and
Fed) have negative global spillovers as US inflation is higher and US growth
slows. The growth drag is generally muted for DM economies with floating
exchange rates but significantly negative for some EM economies (including
China).
Taken together, our analysis suggests that Mr. Trumps policies might act as a
modest drag on global growth. DM growth receives a brief boost from the fiscal
stimulus but then weakens and spillovers into EM economies are negative
throughout. Moreover, the risks around this base case appear asymmetric. A
larger fiscal package could boost global growth moderately more in the near
term, but a more adverse policy mix would likely act as a significant drag on
world growth in subsequent years.

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Goldman Sachs

Global Economics Analyst

Following Donald Trumps victory in the US Presidential election, the focus now turns
to the economic impact of the policies he put forward during the campaign. The
main proposals are substantial fiscal stimulus (via both revenue and expenditure),
tariffs on trade with China and Mexico, restrictions on immigration and a hawkish tilt
for new appointments to the FOMC. The November 12 US Economic Analyst used
the Fed staffs FRB/US model to analyse the implications of these policies for the US
economy.1. Today we simulate the potential economic consequences for the world
economy.

Modelling the Global Repercussions

We examine the spillovers through the lens of our global macro model. The model is
estimated for each of the G7 economies and each of the major EM economies
(China, India, Russia, and Brazil). For each economy, we estimate equations
describing domestic demand, trade, inflation, exchange rates and domestic (excurrency) financial conditions. The box in the appendix provides more details.
We have made two changes to our global model relative to previous versions, both
of which relate to the EM block. First, we update the foreign exchange regime in the
China model and assume that the authorities implement a hybrid between pegging
to the dollar and targeting a basket of foreign currencies. We also consider the
implications of a hard dollar peg and a basket peg for spillovers into China. Second,
we allow (ex-currency) domestic financial conditions in EM countries to be affected
by the bilateral exchange rate versus the dollar. We use this link to proxy for the
possible negative balance sheet effects of a stronger dollar (e.g. due to dollardenominated debt).

The Effects of Individual Policies

We closely follow the analysis in the US Economics Analyst to calibrate Mr. Trumps
proposed policies in our simulations. We explore the following policies:
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1.

A large fiscal stimulus. The proposed fiscal package includes over $400bn of tax
cuts ($250bn in personal and $160bn in corporate taxes) and an infrastructure
spending program (which consists of $14bn in tax credits for every $100bn in
investment).2. We feed the spending boost directly into the model and proxy for
the tax cuts by boosting real disposable income (as our model does not explicitly
contain tax policies).
Tariffs on trade. Mr. Trump has suggested imposing a 35% tariff on imports from
Mexico and a 45% tariff on imports from China. Given US trading patterns, this
translates to an increase in the average effective tariff rate of around 11%.
Whether or not China and Mexico retaliate by imposing similar tariffs on US

See Economic Implications of the Trump Agenda, US Economics Analyst, November 12, 2016.

2.

Mr. Trump also proposes increases in defense spending, but these would occur alongside reductions
in other domestic spending and thus provide little net boost.
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Goldman Sachs

Global Economics Analyst

imports will have an important bearing on the ultimate effect of the policy. In our
simulations, we assume that foreign countries retaliate to an equivalent degree.
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More restrictive immigration policy. Mr. Trumps immigration proposals would

likely reduce the flow of immigrants into the US and we assume that a
nationwide e-verify system would constrain employment of 2.5 million
unauthorized immigrants. We model these effects with a permanent reduction in
both the level and the growth rate of US potential GDP. We calibrate the effects
using our results in the US Economics Analyst.3.
A slightly more hawkish Fed. President-elect Trump must also make several
Fed appointments over the next year, which raises the possibility of somewhat
tighter monetary policy than under current Fed leadership. We assume in our
simulation that the FOMC perceives the equilibrium funds rate to be 50bp higher
than in the September Summary of Economic Projections (SEP).

Exhibits 1 and 2 summarize the global implications of each of the policies taken
separately for the US, Euro area, Japan and China. Exhibit 1 shows the effects on
the level of real GDP (in percent deviation from the baseline); and Exhibit 2 shows
the peak effects on the trade-weighted exchange rates.
Our analysis shows that US fiscal stimulus has positive global spillovers. Higher US
growth feeds through into greater demand for imports which raises growth abroad,
and higher US equity prices ease foreign (ex-currency) financial conditions. Fed
policy is tighter as the labor market overheats and inflation rises in the US. The dollar
reinforces the positive spillovers to DM economies with floating exchange rates
(which depreciate by about 2% against the dollar), but limits the gains in China
(which appreciates by about 1% on a trade-weighted basis in our baseline
simulation).

3.

Specifically, we reduce growth of potential by 0.1pp and the level of potential output by 1.4%.

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Goldman Sachs

Global Economics Analyst

Exhibit 1: Fiscal Spillovers Positive, Others Negative

Source: Goldman Sachs Global Investment Research

The other components of Mr. Trumps agenda (trade policies, immigration and Fed)
have negative global spillovers. In all of these scenarios US growth is lower and
inflation is higher. For example, a more hawkish Fed hikes interest rates more
quickly, which leads to a rise in bond yields, a drop in equity prices and a stronger
dollar. All of these depress US demand, which in turn slows growth abroad. The
growth drag is more muted for DM economies with floating exchange rates but
significantly negative for some EM economies (including China).

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Goldman Sachs

Global Economics Analyst

Exhibit 2: The Response of the Exchange Rate

Source: Goldman Sachs Global Investment Research

The exchange rate plays an important role in shaping the spillovers in each country.
Dollar strength versus DM countries tends to amplify the positive spillovers from a
US fiscal expansion but limits the negative spillovers from growth-adverse policies in
the US. Exhibit 3 shows how the exchange rate regime shapes the net spillovers
into China. The simulations compare our base case with two polar exchange rate
policies: a dollar peg and a TWI peg. Our results show that a dollar peg leads to the
most adverse outcomes for China as the exchange rate does not act as a shock
absorber. The difference is most pronounced for a more hawkish Fed, as China
imports dollar strength one for one. The exchange rate regime in China matters little
for the spillovers from US tariffs (not shown).
Exhibit 3: Spillovers to China Depend on the FX Regime

Source: Goldman Sachs Global Investment Research

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Goldman Sachs

Global Economics Analyst

Adding Up Mr. Trumps Proposals

We next consider the combined effects of these policies. Following the US
Economics Analyst, we consider three scenarios of the Trump Agenda: a full
implementation case that combines the fiscal, trade, immigration, and Fed proposals
above; a benign scenario that includes only the fiscal proposals; and an adverse
scenario that includes tariffs, more restrictive immigration policy and a more hawkish
Fed (but no fiscal stimulus).
Exhibit 4 shows the simulated impact of the full and adverse scenarios (as the
benign package is identical to the fiscal stimulus simulation in Exhibit 1). We find
that the full package boosts US growth slightly in 2017H2 and 2018H1, but then
turns into a drag as the growth-unfriendly policies of the full package start to
dominate. Spillovers into the Euro area and Japan are negligible initially but then turn
negative. The net growth effect on China is negative throughout. The adverse
policies, however, lead to sharply negative spillovers around the world. Real GDP in
the Euro area and Japan is about 0.4% lower after two years, and Chinese activity is
0.9% lower.
Exhibit 5 summarizes the implications of the three Trump packages for world, DM
and EM GDP. The full Trump policies slow global growth by about 0.2pp per year out
to 2020. The effects are initially more benign for DM than EM countries, though the
reverse is true towards the end of the simulation (when the US slows significantly).
The benign Trump scenario boosts world GDP by about 0.4% but turns negative for
EM after about two years. The adverse policy package lowers world growth
significantly. Global real GDP is nearly 0.8% lower after 2-3 years.
Exhibit 4: Two Trump Packages

Source: Goldman Sachs Global Investment Research

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Goldman Sachs

Global Economics Analyst

Exhibit 5: Global Implications of Mr. Trump

Source: Goldman Sachs Global Investment Research

What to Expect
We finally simulate a scenario with the policies that we regard most likely to be
implemented. As discussed in more detail in the US Economics Analyst, we expect
scaled-down versions of the tax reform and infrastructure policies to be enacted. We
do not anticipate significant changes on immigration policy, but incremental
restrictions seem likely. Mr. Trumps monetary policy views are still unclear, but
slightly more hawkish appointments appear likely at this stage. Trade policy is the
greatest unknown, but we expect that Mr. Trump would follow through on at least
some of the trade policies he has outlined. Exhibit 6 summarizes our expectations
and how these compare with the full Trump proposals.4.

4.

We again use the FRB/US simulation results presented in the US Economics Analyst to calibrate the
scenarios in our global macro model.
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Goldman Sachs

Global Economics Analyst

Exhibit 6: Our Best Guess of the Trump Agenda

Source: Goldman Sachs Global Investment Research

Exhibit 7 shows the simulated effects of our expected package in the model. The
left-hand panel shows the real GDP effects for the major four economies and the
right-hand panel summarizes the effects for the main global aggregates.
Exhibit 7: What to Expect

Source: Goldman Sachs Global Investment Research

Our simulations suggest that Mr. Trumps policies might act as a modest drag on
global growth. DM growth receives a brief boost from the fiscal stimulus but then
weakens and spillovers into EM economies are negative throughout. Our analysis of
the alternative policy packages suggests that the risks around this base case are
asymmetric. A larger fiscal package could boost global growth moderately more in
the near term, but a more adverse policy mix would likely act as a significant drag on
world growth in subsequent years.

Nicholas Fawcett
Sven Jari Stehn

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Goldman Sachs

Global Economics Analyst

Box: Our Global Macro Model

Our highly stylized model of the global economy consists of the following equations for each economy in
the G7 (US, Euro area, Japan, UK and Canada) and the BRICs (China, Brazil, India and Russia):
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Domestic demand growth is determined by lagged domestic demand growth, the lagged output gap,
potential real GDP growth and lagged changes in domestic financial conditions (measured with our
GSFCIs excluding the currency). The potential growth and output gap estimates are taken from the IMF
for the G7 countries and are estimated with a statistical (HP) filter for the BRICs.
Export and imports are determined with an error correction framework. In the long run, exports
depend on foreign domestic demand (weighted by export shares) with unit elasticity and the real
exchange rate. In the short run, export growth depends on the lagged deviation from the long-run
relationship, lagged export growth, foreign domestic demand growth and changes in the real exchange
rate. Imports are determined by domestic demand with unit elasticity and the real exchange rate in the
long run. In the short run, changes in imports depend on the lagged deviation from the long-run
relationship, lagged import growth and growth in domestic demand. We allow for deterministic trends
in the long-run relationships for both exports and imports to capture structural changes in world trade
(such as the effects of globalization).
Core inflation is determined with a simple Phillips curve, in which current core inflation depends on a
constant, one lag, the output gap and the recent change in the real exchange rate.

Domestic financial conditions are assumed to have a global factor (calculated as the first principal
component of changes in domestic financial conditions in each of the countries) and a local component
(which is treated as exogenous).
The trade-weighted exchange rate is calculated using the bilateral exchange rates and trade weights
between the countries. The bilateral exchange rates are treated as exogenous.

These equations are estimated for each of the nine economies using quarterly data and the sample period
differs between countries. We complete the model by relating real GDP growth in other advanced and
other emerging countries to those explicitly included in the model.

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Goldman Sachs

Global Economics Analyst

Disclosure Appendix
Reg AC
We, Jan Hatzius, Jari Stehn, Nicholas Fawcett and Karen Reichgott, hereby certify that all of the views expressed in this report accurately reflect our
personal views, which have not been influenced by considerations of the firms business or client relationships.
Unless otherwise stated, the individuals listed on the cover page of this report are analysts in Goldman Sachs Global Investment Research division.

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