Cleveland Federal Reserve President Loretta Mester said Tuesday she backed the central bank’s emergency rate cut in the wake of the coronavirus outbreak “clouding the outlook for the global economy.”
Mester, who is a voting member of the Federal Open Market Committee (FOMC), the Fed’s rate-setting body, said in prepared remarks that while the cut would not fix supply chain dislocations, it would shore up confidence in the economy.
“The virus’s near-term effects on the supply side of the economy, including the reduction in activity from closures, reduced social interactions, cuts in travel and tourism, and disruptions in supply chains, are not things that can be affected by lowering interest rates,” Mester said in remarks for a presentation in London at the Annual Dinner of the Society of Professional Economists.
“The action taken by the [Federal Open Market Committee] can help support confidence and ease financial conditions of indebted households and firms, thereby helping to mitigate potential demand-side impacts of the virus,” she said in her speech.
Besides supply-side disruptions, economists worry the virus scare could dampen consumer confidence. The Paris-based Organization for Economic Cooperation and Development (OECD) warned Tuesday that if the COVID-19 outbreak spreads widely, it could cut global growth in half.
“It is certainly true that rate cuts will not provide a cure for the coronavirus,” said Robert Johnson, Professor of Finance at Heider College of Business, Creighton University, in a statement to The Epoch Times. “But rate cuts will help bolster the financial markets and through the wealth effect will help the underlying economy weather the (hopefully) short-term disruption caused by the coronavirus.”
Responding to a “material change” in the economic outlook, the Fed’s oft-touted condition for monetary policy interventions, Federal Reserve Chairman Jerome Powell on Tuesday announced an emergency rate cut of 50 basis points. The move is the biggest one-time rate cut since the 2008 financial crisis.
“The spread of the coronavirus has brought new challenges and risks,” Powell said at a press conference, adding that he expected the shock measure to provide a “meaningful boost” to the economy.
The Fed’s half-point cut initially prompted a jump on the major stock indexes. But they soon turned negative, with the Dow Jones, Nasdaq, and S&P 500 all closing just under 3 percent down for the day.
Allen Sukholitsky, chief macro strategist at Xallarap Advisory, told The Epoch Times in an emailed statement that markets were not convinced by the emergency cut because the underlying economic data suggest the U.S. economy is in reasonably good shape, sparking investor speculation that the Fed is acting on information that the epidemic is worse than it appears.
“No economic data released over the last week would justify an unscheduled rate cut, let alone the largest rate cut since the financial crisis,” Sukholitsky said. “The proximate driver was the S&P 500, which experienced a correction, albeit one that was well within historical averages. Equities are now in the red because they sense inconsistency between this rate cut and the Fed’s statement that ‘fundamentals of the U.S. economy remain strong.’”
Mester said in her remarks that prior to the virus-related clouding of the outlook, the economy was indeed projecting strength, with inflation on point to hit the Fed’s 2 percent target, buoyed by a robust jobs market and consumer confidence.
“In contrast to soft business spending, consumer spending has been driving the U.S. economy forward, and that has been the case for most of the expansion,” she said. “Solid fundamentals have helped to support consumer spending. Household balance sheets are healthy.”
But the outbreak has cast a shadow of uncertainty over the economy, she said.
“Much is still unknown about the disease making it difficult to predict how large and persistent the economic impact will be,” she said.
“Heightened and persistent uncertainty can affect the economy. It raises the possibility that negative effects on consumer and business sentiment and a pullback in investor risk-taking could last after the spread of the coronavirus has stabilized,” she added, warning that, under such circumstances, “the supply shock could evolve into a demand shock.”
The emergency rate cut aims to prevent the outbreak from sapping consumer sentiment and draining demand, she said.
Sukholitsky, meanwhile, argued the Fed fired its policy bullets prematurely and now “little room remains for a traditional policy response during the next recession.”
The U.S. economy is now in its 11th year of a record-long boom.