The Fed Pushes for More Stimulus—Why?
Dear Rich Lifer,
This seems to be the most common word to describe the times.
We are sure you’ve written at least one email beginning with, “In these unprecedented times….”
The word has permeated the news, our correspondence with colleagues and our everyday conversations.
So it may not surprise you that another unprecedented event has occurred.
This time we are talking about the Fed.
In “normal” times, Fed officials typically refrain from dipping their toes into political debates.
They prefer to preserve their autonomy over managing individual monetary practices rather than make public recommendations on spending, tax or other policy matters handled by the government.
However, we are not in “normal” times.
We are in unprecedented times.
Powell Weighs In
Fed Chairman Jerome Powell has been firm in expressing his opinion that Congress needs to do more to compensate for income losses sustained by unemployed workers and revenue holes facing hard-hit businesses and city and state governments due to the coronavirus pandemic.
Other officials have been even more vocal in their dissatisfaction, with Chicago Fed President Charles Evans blaming partisan politics for the lapse in federal unemployment benefits stating, “A lack of action or an inadequate one presents a very significant downside risk to the economy today.”
The recent rise in employment (1.4 million Americans have found or resumed work) is marked as a positive advance.
The U.S. economy lost nearly 22 million jobs between February and April but has recovered around half of those since May. Unemployment has fallen from 10.2% in July to 8.4% today.
However, Powell still maintains that the economy will require more government spending and low-interest rates for years to come.
“We do think it will get harder from here,” said Mr. Powell in an interview with National Public Radio at the beginning of September.
Powell maintains his position that Congress and The White House need to spend money and provide additional relief, such as moratoria on rental evictions, to prevent longer-term damage from holding back the economy.
There are two reasons Fed officials are eager for continued aid.
The first is because of the limits of their economic stimulus tools — something that was becoming clear even before the pandemic.
The second is because of the unprecedented (there it is again) nature of the current shock.
Is “Forward Guidance” the Answer?
Fed officials began a two-day meeting today, September 15, where they will discuss how exactly to implement their new average inflation framework.
These changes, announced in August, were a response to an inadequacy in their old framework, which failed to account for more persistent and extended periods at the so-called “lower bound,” where interest rates can’t be further lowered once falling to near zero.
If the central bank targets 2% inflation and consistently falls short once rates are pinned that low, expectations of future inflation can slide, causing inflation and rates to stay low.
The new policy tries to break this continuous cycle by seeking slightly higher periods of inflation after periods of below-target inflation.
Because the Fed doesn’t want to cut rates below zero, they are focusing on how to provide continued stimulus through “forward guidance” identifying how long they plan to keep rates very low and continue purchasing Treasury securities and mortgage bonds.
Forward guidance and asset purchases helped lower long-term rates after the 2008 crisis. However, they may be less impactful today, because long-term yields are much lower — a reflection of how investors assume this period of low rates will continue.
In fact, half of the economists surveyed by The Wall Street Journal said they don’t foresee the Fed raising rates till 2024.
For this reason, there are doubts that “forward guidance” will actually be effective in creating monetary stimulus.
Why Today Is Different
Michael Woodford, a Columbia University economist who is influential in central banking circles has new research that shows increased government spending would be more effective than monetary stimulus.
Traditionally, in downturns, central banks can help stabilize the economy by lowering interest rates; however, Woodford says this is not as effective when certain sectors of the economy aren’t able to operate for noneconomic reasons — in other words, during a global pandemic.
Woodford encourages us to look at the economy as if it is a network of payments. There is a ripple effect involved when income plunges in certain sectors such as hotels, restaurants, or concert venues.
For example, if business owners in these sectors can’t pay rent, then landlords have less money to maintain their staffs and cities face a bigger erosion of their tax base, thus prompting more layoffs.
Woodford states, “These later steps in this chain of effects are all suspensions of economic transactions that are in no way required by the need to stop supplying in-restaurant meals and theater performances.”
Therefore, he argues that government spending can respond more directly to aiding in the continuation of such flows of payment.
This is a huge challenge for the Fed because certain parts of the economy, like housing and technology, are being overstimulated while other parts, like the arts, are struggling.
Recovery is happening in a very uneven way leaving officials and analysts conflicted about the best way to move forward.
Some Fed officials want more details about how the economic recovery is unfolding before making decisions to increase stimulus.
Other analysts say that central banks should follow through on their new framework guidelines by delivering more specific guidances.
Only time will tell which approach is best.
Certainly, there will be more information once the official Fed meetings conclude on Wednesday. September 16.
To a Richer Life,
The Rich Life Roadmap Team