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There is a nagging sense the emergency 50-basis-point rate cut to support an economy that is battling the coronavirus is like placing a Band-Aid on an arm to cure a headache. One is hard-pressed to see how precisely this easing in monetary policy will effectively counter fears of getting ill from this pathogen.
True, the Federal Reserve in recent days has come under tremendous pressure from both the futures market and the White House to slash rates. President Trump and his key advisers, Larry Kudlow and Steven Mnuchin, were publically urging Chairman Powell to act quickly.
And yet the critical tweets from Trump still have not ceased even afterward. Trump is explicitly urging the Fed to weaken the value of the dollar, even though he consistently threatens punitive actions against countries who manipulate theirs.
From an economist’s perspective, it is baffling to see how the latest action by the Fed will help buttress the real economy. I suppose one could speculate that Powell obtained an advance copy of Friday’s release of February’s employment report and saw something troubling.
But in Powell’s press conference today, he began by reassuring everyone that the economy is fundamentally sound, pointing to continued strong job growth and rising incomes.
He did point how this exogenous shock has hurt travel and tourism and disrupted U.S. and international supply chains. But the cure for that is to contain the coronavirus, not lower borrowing costs.
Keep in mind that rates were already historically low even prior to the outbreak of the coronavirus. This raises the question whether over the last 30 years Americans have accepted low interest rates and negligible inflation as the new normal. That would be worrisome since one is then making the argument that dirt-cheap credit must be made even cheaper –– or the new virus will devour the economy. It’s a hard sell.
As we pointed out on Monday, by cutting rates now the Fed really painted itself into a corner. If the coronavirus ceases to be a threat by summer and the emergency is over, then the FOMC would prefer to reverse those cuts as the economy recovers. But does anyone think they would hike rates in the final months of a contentious presidential campaign?
Finally, there is the broader question of whether the Fed’s emergency action had the perverse effect and only deepened public anxiety. Case in point: After the Powell press conference, the Dow Jones Industrial Average DJIA, -3.28% continued its free fall.
Read: CNBC’s Jim Cramer says ‘I’m more nervous now than before’ the Fed’s rate cut
Bottom line: In the absence of any fresh data showing the U.S. economy slipping into recession, the Fed should now be done for the year. If the economy were heading into a recession, here are the leading indicators at this juncture that would signal such a turn:
1. A sharp increase in the personal savings rate.
2. Sustained drop in retail sales.
3. Persistent fall in the monthly consumer confidence numbers.
4. Sharp increases in applications for unemployment benefits.
Bernard Baumohl is the chief global economist at The Economist Outlook Group in Princeton. N.J.
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