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Democrat sweep to open fiscal floodgates and boost growth

08 January 2021 Keith Wade, Chief Economist at Schroders

The disturbing scenes of protestors storming Capitol Hill last night may have soured the victory, but nonetheless the Democrat Party now have control of the Senate and the House of Representatives for the first time since 2009.

They now have control of Congress and are in position to implement much of President-elect Joe Biden’s agenda.

The near term impact will be greater fiscal spending, with Biden having already described the recent $900bn bill as a “down payment”. Expect an enhanced bill with the stimulus cheques most Americans are set to receive increasing from $600 to $2000, an extension of higher unemployment benefits (from March to June) and increased spending on state and local government. This could add up to another $900bn to the fiscal boost.

Looking further out, there is also the likelihood of an infrastructure bill with an emphasis on clean energy. However, we can also expect higher taxes particularly on the corporate sector, which will weigh on profits.

Our previous baseline expectation was for a split Congress, so the Democrat sweep means we will be increasing our economic growth forecasts for this year and next.

There is still a difficult winter to get through with Covid-19 cases soaring and we would have to see the details of the fiscal stimulus. But normal multipliers would suggest adding 1 percentage point to US GDP this year and next. This would take our forecasts to 4.8% and 4.5% for 2021 and 2022 respectively (up from 3.8% and 3.5%).

Such growth would reduce unemployment and close the output gap faster, which in turn would mean greater inflationary pressure. Consequently, we would be looking for an earlier rise in the Fed’s target interest rate, potentially in 2023 rather than 2024.

Although the events of Wednesday night mean that risks remain over a smooth transition of power, the likelihood of a sharp v-shaped global recovery has increased.

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