The Federal Reserve decided today to cut its primary interest rate by half a percentage point in an attempt to ease the global economy’s adverse reaction to the novel coronavirus.
But the US central bank is, in central-banker parlance, pushing on a string.
To the Federal Reserve, every problem looks like a potential credit crunch, and the only solution is more rate cuts. In fact, what the markets need is for US president Donald Trump to abandon his shambolic approach to a virus that’s on the cusp of being labeled a pandemic, and begin taking meaningful action to address its economic effects. That’s what would trigger confidence among investors, and minimize the impact on global economic growth.
Instead, Trump has kept up his drumbeat of blaming the Fed for economic conditions, demanding a new round of rate cuts in a tweet this morning (which Powell said did not influence the Fed decision). In reality, markets have plunged because Trump has downplayed the crisis and failed to manage the response of the US government, which lacks three essential ingredients: coordinated leadership, a reliable test for the disease, and accurate estimates of the cost of action.
In 2018, Trump national security adviser John Bolton fired rear admiral Timothy Ziemer, the White House official in charge of coordinating the response to a global epidemic, and disbanded his office. Now, experts say the White House is missing the mark. For instance, even basic precautions were not taken by workers dealing with isolated victims of the disease in the US, allowing it to spread beyond quarantine.
Varieties of shock
From an economic point of view, looser credit conditions are unlikely to reverse market declines driven by concerns about slowing economic activity in China, falling travel and tourism, and lower production overall as the virus spreads.
Markets appear most worried that the virus will cause what economists call “supply shocks.” Already, products and components that US businesses expect to arrive aren’t coming because Chinese factories are closed to prevent the spread of Covid-19. More businesses will face labor shortages if employees must stay home due to quarantines or school closures.
Cutting interest rates, meanwhile, is all about goosing demand for goods and services. That’s why it works during a traditional recession, when the economy tends to have a plentiful supply of idle workers and raw materials, but lacks the spending to get them into action. When unemployment is high, looser credit conditions can help businesses get those workers once again producing, and spending their paychecks. But there’s little reason to believe that more access to capital will help companies get sick workers back faster.
We can anticipate some demand shocks likely to be associated with the pandemic. Businesses dependent on crowds—like sports leagues, movie theaters, and malls—are likely to suffer as more people stay home. And idled workers will have to slow their spending on even basic goods if they can’t get regular hours at their jobs.
Even then, it’s unlikely that the credit system can solve these problems, dependent as it is on people showing up for work. In any case, as JPMorgan Asset Management’s chief global strategist, David Kelly, notes, “many years of very low interest rates suggest that there is very little economic activity that is being held in check by financing costs anyway.”
The Economic Policy Institute, a left-leaning think tank, suggests short-term measures that would generate confidence and real economic impact, like pledging that the government will cover all health-spending related to Covid-19, a measure taken by South Korea. This could alleviate spending concerns among citizens who worry about future medical bills and also improve self-reporting and treatment, a boon for public heath efforts.
The Institute also suggests that lawmakers could provide short-term cash payments to households, or take on cost-sharing measures, to make up the difference for workers who see hours reduced because of the spreading virus. These payments could prevent the demand shock if low-income workers miss weeks of paychecks.
That’s also the logic behind income-tax cuts being pitched as helpful by some Republicans, but using income taxes as a transmission channel for fiscal stimulus will push the benefit toward higher earners who don’t need it. A more targeted intervention would be temporary payroll tax cuts for workers and one week of mandated temporary sick leave.
To be fair to Powell and the rest of the Federal Open Markets Committee, the central bankers surely recognize they are acting mainly to ensure the public that at least one US institution is taking steps to address the crisis. And should the economic slowdown prove long-lasting, getting ahead of a recession may prove valuable.
“We do recognize that a rate cut won’t reduce the rate of infection, it won’t fix the supply chain…[but] we do believe our action will provide a meaningful boost to the economy…and it will boost household and business confidence,” Powell said today.
Public confidence now depends on whether Trump’s team can put in place the basic public-health measures, like widespread testing, seen in other countries. Otherwise the administration’s lack of credibility will only grow as the facts of the pandemic outstrip the president’s attempts to minimize it. He has thus far argued, for instance, that warm weather or the flu vaccine will stop its spread (neither will.)
If such statements continue to drive the US response, monetary conditions won’t protect the economy. Just ask investors, who sent the Dow Jones Industrial Average down by more than 2% and the S&P 500 index down more than 1.8% in midday trading, after the Fed cut its rate target.
“The ultimate solutions to this challenge will come from others, particularly health professionals,” Powell acknowledged at his press conference. He may also have meant the White House, but perhaps that’s too much to hope.