Outlines of US response to coronavirus coming into relief

After quick monetary policy action, fiscal policy taking centre stage

Over the last week, it appeared that US officials were flailing in their efforts to develop an effective economic response to coronavirus. While the response still seems somewhat haphazard and uncoordinated, the outlines appear to be coming into relief.

One major element of the debate has been around the mix of fiscal and monetary policy measures to tackle the economic impact.

President Donald Trump predictably first looked to the Federal Reserve to lead the coronavirus response, and still tweets to that effect.

On monetary policy, the Fed quickly responded last week with its 50-basis point intermeeting cut in the Fed Funds rate. Markets are expecting another huge cut in the funds rate at next week’s Federal Open Market Committee meeting. Many analysts predict that the Fed will be aggressive and pre-emptive, with the funds rate heading to zero this year. They are discussing whether the central bank would amp up its forward guidance, further build up its balance sheet, and even consider more aggressive lending schemes to businesses, dusting off some of the facilities deployed in 2008. The jury on FOMC thinking is decidedly out.

Meanwhile, the Fed market desk has stepped up its provision of ample reserves to the financial system, clearly intent on avoiding any recurrence problems as emerged last year in the repo markets.

Many economists pointed out, though, that the central bank was not well placed alone to tackle what in many respects was a supply shock. They argued fiscal policy action was needed, if not more central.

Congress and the White House did immediately act to implement an $8bn package to address medical and health needs. But the idea of a broader fiscal response appeared to receive pushback from the White House, and particularly from Larry Kudlow director of the National Economic Council.

US fiscal policy is, however, appearing to take centre stage. The White House is apparently backing a payroll tax cut and liquidity to businesses. The president has also discussed seeking assistance for airlines, hotels and the cruise industry, though there are as yet no plans for this. Generalised tax cuts seem unlikely.

Meanwhile, the Democrats are emphasising paid sick leave, which many American workers lack, as well as unemployment insurance, small business loans, and increased funding for food stamps, including for women, infants and children. They may push back on the idea of a payroll tax cut, as it would do little for the unemployed.

These approaches will have to be melded into legislation. More health spending will be needed. While it often seems Congress is incapable of passing legislation, in the current circumstances fast action is probable. Expect many elements of both to appear. Total magnitudes have not been discussed, but a large response – perhaps on the order of a few percentage points of GDP – is likely. The US fiscal path is hardly ideal, but the one-time addition of a few percentage points to the debt-to-GDP ratio will not be problematic, especially when interest rates are well below 1%.

One of the key coronavirus challenges is that households and businesses may face liquidity crunches in meeting loan repayments. The federal regulators, however, issued a welcome statement urging US financial institutions to work constructively with borrowers and others, consistent with prudent and sound lending practices. US institutions can thus be somewhat assured that reasonable efforts to help borrowers and households will not trigger supervisory actions, which might otherwise cause unwarranted defaults given that the virus impact will hopefully be ‘temporary’. The Treasury should deploy the Financial Stability Oversight Council.

The coronavirus shock will clearly depress US near-term growth. The collapse in oil prices is also a shock that many on its face think will positively benefit consumption.

However, given the important role of the energy patch in the US economy and that its financing is often considered high-risk, lower oil prices could hamper overall investment and seriously harm the health of energy firms. Americans may step up saving. On balance, the collapse in oil prices, if sustained, may not substantially impact aggregate US growth.

Tremendous unknowns remain about the virus in the US, such as the numbers affected and how much further it is likely to spread. Quarantining efforts appear to be picking up. But continued financial market volatility is to be expected.

Mark Sobel is US Chairman of OMFIF.

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