Federal Reserve policy makers sound cautiously confident they’ve got interest rates about right as they assess the fallout from the spreading coronavirus.
What worries them though is their ability to rescue the U.S. economy should things go horribly wrong.
In various venues this week, policy makers from Vice Chairman Richard Clarida on down talked up the resilience of the economy and gently pushed back against mounting financial-market expectations they’ll cut interest rates by mid-year.
“The economy is pretty good,” Atlanta Fed President Raphael Bostic told CNBC television on Friday, adding he had “no impulses” to change interest rates.
Behind the near-term optimism lies a longer-term concern. With interest rates already at low levels, the Fed has limited ammunition to combat a recession should one occur — be it in response to the coronavirus or some other unforeseen shock.
That’s a quandary that Fed Governor Lael Brainard tackled head-on in a Friday speech in which she called for a new recession-fighting strategy that would include caps on Treasury debt yields.
U.S. stocks sank, gold surged and Treasury yields tumbled on Friday as investorstook a defensive stance amid renewed concern about the economic impact of the virus as it spreads outside of China.
Fed policy makers, for their part, have their fingers crossed that the epidemic will be contained and that any impact on the U.S. economy will prove to be temporary.
“The base case is that, as other viruses have dissipated, this one will also dissipate,” St. Louis Fed President James Bullard said on CNBC Friday.
“If you think the virus is going to dissipate and we’re going to have a temporary shock and everything is going to go back to normal, yeah, I think the Fed is in great shape and we don’t have to lower rates in that scenario,” he added.
Fed officials left interest rates unchanged in a range of 1.5% to 1.75% at their Jan. 28-29 gathering and said the setting was “appropriate” to sustain the U.S. economic expansion and achieve the central bank’s goals of maximum employment and stable prices.
The coronavirus has so far killed more than 2,200 people, mostly in China, and infected more than 75,000, while disrupting travel and commerce worldwide.
In a sign the U.S. economy isn’t immune to the fallout, a measure of business activity shrank in February for the first time since 2013 as the contagion hit supply chains and made firms hesitant to place orders.
The IHS Markit purchasing managers’ index measuring composite output at factories and service providers fell by 3.7 points to 49.6, the lowest level since October 2013, when the U.S. government shut down, according to preliminary figures released Friday. Readings below 50 indicate contraction.
Bank of England policy maker Silvana Tenreyro warned that the coronavirus outbreak could have a big impact on the world economy.
“Even if the virus is contained within China, the impact on global GDP might be large given the size of the Chinese economy,” Tenreyro said Friday at the University of Chicago Booth School’s Monetary Policy Forum in New York.
It was at that forum that the Brainard laid out her plan for beefing up the U.S. central bank’s recession-fighting capabilities.
Under her proposal, the Fed would cut rates as low as it can in a downturn and then pledge to keep them there until full employment and 2% inflation is achieved. It would back up that promise with interest-rate caps on short-term U.S. Treasury securities.
Brainard would also have the Fed seek above-target inflation to make up for past undershoots of its 2% price objective.
Brainard’s plan is just one of a number under consideration by the central bank as it carries out an in-depth strategic review it expects to complete around the middle of this year.
The review is aimed at coming up with ways for the Fed to cope with what Chairman Jerome Powell has called a “new normal” of subdued inflation and historically low interest rates.
With its short-term rate target currently at 1.5% to 1.75%, the Fed has less than half the 500 basis points in rate cut ammunition it’s used in past recessions.
“The current generation of central bankers faces a different core challenge than the last generation, with substantially smaller scope for cutting interest rates to buffer the economy,” Brainard said.
In publicly staking out where she thinks her fellow policy makers should go, Brainard acknowledged that the changes she was proposing may not be sufficient to fully offset future economic contractions.
“In addition to a forceful response from monetary policy, robust countercyclical fiscal policy is vital,” she said.
“Just as monetary policy makers are actively reviewing their tools and strategies, now is the time to undertake a review of fiscal tools and strategies to ensure they are ready and effective,” she added.
— With assistance by Michael McKee, and Craig Torres
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