3/9/2020
There has been debate among Wall Street economists about last week’s cut, as the unconventional action (and its magnitude) seemed to both soothe and incite concern in financial markets. The new lower rates may help boost borrowing and ease the penalty for taking on debt, while also spurring questions like, ‘are conditions worse than we think?’
There is some precedent for between-meeting rate cuts, but they’ve tended to be in ‘emergency’ situations to stabilize markets, including events as significant as 9/11, the global financial crisis, and the collapse of Long-Term Capital Management in 1997. Whether these helped or not is debatable, but did seem to calm nerves and provide a sentiment boost to market participants that the Fed intended to serve as a stabilizing force. The impetus for the current cut is likely rooted in easing conditions for corporate bond markets particularly, which would be more sensitive to a quick-onset recession (from any source).
It remains to be seen whether the coronavirus stacks up as serious enough to warrant the cut, but there are other factors likely involved in the volatility of the past few weeks. The other is the progress of the Presidential election, where the early success of Bernie Sanders spooked markets due to a perceived anti-business and pro-tax platform, while the more recent resurgence of Joe Biden as a more mainstream candidate appeared to temper that fear a bit—especially in the aftermath of Super Tuesday.
A problem in determining recession probabilities is the qualitative component. It has been shown that a pessimistic outlook can create a downward spiral, causing businesses and households to tighten belts, and stop spending…creating less revenues for the economy, begetting job losses, and creating the very situation feared in the first place. This is the reason so many politicians and economists focus on consumer and business spending as a key lubricant to keep the economic engine moving. Lower interest rates may act help provide a quick boost, perhaps enough to get over the hill and avoid a recession, but the eventual effects may peeter out, or even cause negative byproducts, such as overly-inflated markets for financial assets and real estate.
These concerns were apparently outweighed by a Fed concerned over already low forecasts for global growth in 2020-21, and low current inflation—situations they’ve addressed perhaps more than any others in recent commentary. However, there is a limit to stimulus, which could be the zero bound (again), since there is far more of a reluctance in the United States than elsewhere to move into negative interest rate territory.
More promise might be in potential government fiscal policy, as was done in 2008 and other challenged environments, including tax and lending incentives for small businesses, as well as other tools, such as tax cuts or enhanced unemployment benefits for workers, if needed. However, as with easier monetary policy, an easier policy won’t help spending if virus-related production slowdowns create a physical scarcity of supply, as opposed to a lack of demand. If it came to it, the best case would be for policy to ‘buffer’ the economic damage somewhat for businesses and consumers before conditions returned to normal.