What if the Federal Reserve Can't Undo the Coronavirus Recession?


What if the Federal Reserve Can't Undo the Coronavirus Recession?

Perhaps another large stimulus is needed (if Congress can agree to one).

Comments by Fed Chairman Jerome Powell that the Federal Reserve lacks the policy tools needed to achieve objectives related to U.S. employment and inflation have increased concerns that monetary policy can no longer create demand in the U.S. economy and that further fiscal stimulus is needed. 

Following the Sept. 15-16 policy-setting Federal Open Market Committee meeting, the Fed signaled its policy interest rate will remain near zero at least through 2023. It slightly refined nebulous guidance unveiled in August, tying it more closely to unemployment falling to the "maximum employment level," which Powell suggested in his press conference may be roughly the 3.5 percent unemployment rate prior to the COVID-19 lockdown. 

-That enhanced the August guidance that shifted to "inflation averaging" from inflation targeting, and allows inflation to overshoot 2 percent for a period without triggering preemptive increases in interest rates when inflation approaches 2 percent.

Using a so-called "dot plot" to share their expectations and policy path for interest rates, committee members conveyed a longer term forecast that effectively says they do not anticipate a rise in interest rates in the foreseeable future. The plot suggests only one committee member of 17 expected a rate hike before 2023 and only another three during 2023. Nearly all expect long-term interest rates to top out at 2.5 percent, with only three seeing them as high as 3 percent. Two of the 10 current voting committee members dissented from the decision, but that pair favored even lower interest rates for a longer period, not policy tightening. Powell emphasized the committee's unanimous support for the framework of flexible average inflation targeting. Nonetheless, the Fed is effectively saying its policy interest rate will be near zero for an extended period.

-The Fed hasn't shown any ability to attain the necessary inflation conditions since it adopted the 2 percent target in 2012 with the core personal consumption expenditure deflator — its preferred inflation measure rather than the consumer price index — averaging only 1.4 percent and exceeding 2 percent only twice. The core PCE has averaged 1.6 percent for 10 years.

-Moreover, it predicts inflation only as high as 1.7 percent for all of 2021 and no members expecting inflation of more than 2.0 percent as late as 2023 (the outside limits of participants' forecasts).

-In addition, the Fed failed to specify credible monetary policy actions to get inflation back to a 2 percent average, which implies some unspecified period of "overshooting" above the 2 percent average target.

Powell emphasized that U.S. economic recovery depends on control of the COVID-19 pandemic and new fiscal stimulus in support of jobs and income. The committee reiterated its view that "the path of the [U.S.] economy will depend significantly on the course of the virus" with "considerable risks to the economic outlook over the medium-term." Meanwhile, updates to the Fed's quarterly forecasts include:

-U.S. GDP expected at -3.7 percent (2020) compared with the June forecast of -6.5 percent, and 2021 growth expected at +4 percent.

-Unemployment falling to 7.6 percent by end-year and 5.5 percent by end-2021.

-Inflation of 1.2 percent in 2020, up from the June forecast of 0.8 percent, and a climb to 1.7 percent next year.

Powell was less clear with regard to the Fed's quantitative easing policy tool; the Fed would probably make changes in amounts purchased and their maturities as the first step in any policy change. For now, bond market purchases will continue at $120 billion a month, including $80 billion in Treasury securities and $40 billion in mortgage-backed securities. The Fed's balance sheet has increased by about $3 trillion in the last six months.

As for emergency lending programs, the Main Street Lending Program, in which the Fed buys 95 percent of bank loans to small businesses, has committed only $1.4 billion of $600 billion authorized. Commercial lenders retain some of the credit risk, which neither the Fed nor the Treasury is willing to assume, effectively giving banks no incentive to approve loans. A shift in Treasury guidance or Congressionally approved changes would provide more funds for many small businesses, but it is tied up in stalled stimulus talks between the White House and congressional Democrats.

Separately, U.S. retail sales increased in August by 0.6 percent, a slowing of the pace in July. Personal consumption in the United States is still below its pre-pandemic level. Slower retail sales coincided with the expiration of the extra $600 per week in expanded unemployment benefits.

U.S.: Is the Fed Out of Ammo? is republished with the permission of Stratfor Worldview, a geopolitical forecasting and intelligence publication from RANE, the Risk Assistance Network + Exchange. As the world's leading geopolitical intelligence platform, Stratfor Worldview brings global events into valuable perspective, empowering businesses, governments and individuals to more confidently navigate their way through an increasingly complex international environment. Stratfor is a RANE (Risk Assistance Network + Exchange) company.

Image: Reuters.