Corporate tax cuts are likely to have a positive effect on economic growth, and could buoy the equity markets by raising after-tax earnings and corporate investment.

Republicans agreed in principal in late December on a final tax bill that would cut taxes for businesses and individuals. It’s worth noting that with the corporate tax rate at 26%, lowering it to 20% or 22% in 2018 or 2019 is not going to transform the economy. Still, an estimated 60% of companies may benefit from a tax cut. Therefore, the tax reform could create some upward momentum in growth.

At the margin, corporate tax reforms could buoy the equity markets by raising after-tax earnings and corporate investment. Investment projects that are currently not viable could become more possible with a lower tax rate. Of course, the cost of capital is already low, but while the effect may be small, we should see a measurable positive impact on growth.

The household tax cuts will have little impact on consumption because they are, in net terms, very small and geared toward high-income households. But the rally in equity markets creates a wealth effect, and this will boost consumption growth in 2018. The labor market is key to household income and spending, and it continues to improve, albeit at a slower pace. Consumption growth in 2018 is expected to mirror 2017 and may be a little bit stronger.

At the margin, corporate tax reforms are likely to help the equity market by raising after-tax earnings and boosting corporate investment.

Recession risk remains limited

The relentless flattening of the yield curve since September has produced some concerns that a recession is just around the corner. If the yield curve keeps moving the way it has, pretty soon it will be inverted, goes the argument, and then there’ll be a recession.

This reasoning deserves some skepticism. Recessions are infrequent, and precisely because they’re infrequent, they are hard to forecast. Different recession-forecasting models take different approaches, and while none of them is perfect, neither do any of them suggest a recession is just around the corner.

Recessions are infrequent, and precisely because they’re infrequent, they are hard to forecast.

Today, in other words, the business cycle is unlikely to cause a recession. While an external geopolitical shock from North Korea or the Middle East could precipitate a downturn, the most likely route into a recession, in our view, is inappropriate monetary tightening. An overly aggressive Fed could produce a sharp downturn in the economy. And it’s worth bearing in mind that the FOMC is losing a lot of experience with Stanley Fischer gone, and with Janet Yellen and William Dudley leaving in early 2018.

Next: Brexit negotiations stumble


More from Macro Report
Download the Macro Report (PDF)

The acceleration in global growth witnessed in 2017 will continue well into 2018, but with significant changes in its components.