What the Fed can do to help with with coronavirus’s economic aftershock

March 4th, 2020

While the Fed acted preemptively Tuesday, it is still too early to say much that is definitive about the economic threat from coronavirus. We do know, however, that this is one of the most dangerous and disruptive disease outbreaks since World War I.

Science and medicine have of course progressed massively since the 1918 Spanish flu. On the other hand, the world has nearly five times as many people now, and our interconnection is vastly greater, with 2.8 million people flying each day, in the United States alone, inside metal tubes with recirculating atmospheres. Large fractions of the world population live in places with little ability to carry out systematic health policies.

According to the Centers for Disease Control and Prevention, roughly one-third of the world’s population was infected with the deadly Spanish flu, and 50 million people died — about 3 percent of global population then and a mortality rate of about 1 in 10. Suppose with novel coronavirus the mortality rate turns out to be 1 percent and the disease reaches 10 percent of the world, so that fatalities amount to not 1 percent but 0.1 percent of the global population. The result would be more than 7 million deaths.

What we have seen so far has already had far-reaching economic effects. International meetings are being canceled. Shipments from Asia to the Port of Los Angeles are likely to be down by 25 percent in February. Financial markets, which are forward-looking, lost $6 trillion over six days before regaining some of the lost ground. It is close to an even chance the U.S. and global economies will go into recession in the next 18 months.

The questions in the current moment properly revolve first and foremost around public-health strategy. But there is much for economic policymakers to consider as well. Unfortunately, the tool that has received the most attention — monetary policy — is not likely to be very effective in a crisis of this kind, and the way it’s used could create problems down the road. It may on balance be desirable to cut interest rates — as the Fed voted to do Tuesday ― but the principal focus should be elsewhere.

Common sense offers the most important point. When, as in the 2008 financial crisis, output is dropping because consumers and businesses cannot afford to repay loans or get new ones, lowering interest rates and making more credit available is the natural and appropriate policy response. But when GDP falls because businesses cannot get components necessary to generate output, because quarantines limit people’s ability to work and because potential customers are rationally afraid to enter public spaces, then monetary policy is much less useful.

Moreover, this is all happening when the efficacy of monetary policy may already be largely exhausted. With 10-year U.S. rates approaching 1 percent, high uncertainty and limited room for cutting short-term rates, it is far from clear how much monetary moves can encourage economic activity, even without a pandemic.

There are also tactical issues to consider. The hardest moments for economic policymakers are when the power of the tool at their disposal is less than what is generally supposed. In such a circumstance, policy can function better as a potentially potent “sword of Damocles” than it would if its limited efficacy were laid bare. Closely related to this is the idea of never shooting your last bullet. And to the almost inevitable extent that it would appear political, a sharp move to easy money may undercut the Fed’s credibility.

Despite all this, Tuesday’s rate cut may nonetheless have been the right option, simply to avoid adding disappointment with the central bank to the current challenges. But the benefits of monetary pyrotechnics like Tuesday’s in the form of extraordinary timing and size of monetary moves have to be balanced against the alarm they may cause and the way they leave central banks exposed as lacking effective tools.

Much more attention should be devoted to economic policies better targeted at pandemic risk.

First, central banks should develop a facility to assure that credit is not cut off to key sectors of the economy, come what may. Steadily available credit is much more important than lower-priced credit.

Second, as huge excess capacity at major global ports suggests, this is a moment for less — not more — interference with trade flows. Though it may go against the president’s instincts, the United States should lead a global effort to reduce tariffs as a source of stimulus for the duration of the health emergency.

Third, planning should begin for fiscal expansion via federal budgetary investments in areas like the purchase of ventilators, videoconferencing equipment and distance-education technologies, all of which are directly connected to the coronavirus problem. And, of course, there is far more risk of spending too little on health research and production of health goods than in spending too much.

Fourth, international financial institutions’ failure to move to help the world’s poorest countries at a moment when they could suffer an AIDS-level catastrophe is scandalous. The United States should use its influence to assure that the International Monetary Fund, World Bank and regional banks step up on behalf of all nations, for all nations.

Just as the 2008 financial crisis upended the 2008 presidential election, coronavirus may upend this presidential campaign. 2008 was about money and the economy. This will be about money and life and death.