Federal Reserve officials do not seem to be buying what tax cut advocates are selling, namely that economic growth will offset the proposed rate reductions.
Even with the sharp uptick in 2018 GDP projections, central bank policymakers view gains in coming years as muted and more in line with the post-financial crisis trend. Following its meeting this week, the Fed pushed its estimate for 2018 from 2.1 percent to 2.5 percent, but then said the level would fall to 2.1 percent and 2 percent in the following years.
President Donald Trump and his team of economic advisors, along with the Republican congressional leadership, have pitched the tax plan largely on hopes that it would generate economic gains of 3 percent and upward.
The Fed projections don't follow that script, setting up a potential conflict between policy projections and conditions in the real economy.
"It's clear from [the estimates released Wednesday] that the Fed doesn't think that Trump's tax cuts will give a substantial long-run boost to growth. This is about as close as the Fed will get to saying the policy was mistimed," said Luke Bartholomew, investment strategist at Aberdeen Standard Investments.
Indeed, critics of the tax reform plan have attacked it on three fronts: that benefits are tilted toward high earners, that it will explode the budget deficit, and that with the economy recovering on its own and near full employment, tax cuts will have limited benefit and could stoke inflation.
Supporters counter that the moves will free up trapped money, encouraging business investment and consumer spending that will lift the economy out of its subtrend growth experienced during the recovery.
So far, the trend seems to be on their side, with the Fed and others increasing their GDP projections and retail sales from November well ahead of Wall Street estimates, even with tax cuts not yet approved. The Fed's own Atlanta branch now sees fourth-quarter GDP rising to 3.3 percent, which would bring the average of the year's final three quarters to 3.23 percent and the full-year average to 2.7 percent, well above the 2.1 percent during the previous recovery years.
From the policymaking Federal Open Market Committee's perspective, the question will be whether it will need to step in to put the brakes on runaway growth or will it be able to continue its gradualist approach to policy normalization. The FOMC this week voted to hike the central bank's benchmark interest rate target a quarter point, the fifth such move since December 2015.