The Federal Reserve Open Market Committee’s March 3 decision to cut its short-term interest rate target was bizarre.
The announced goal was to counter possible adverse economic effects of the growing pandemic. However, it was so poorly thought out that it confirms we are now in a surrealistic Bizarroworld of economic policymaking where coherence and consistency of monetary and fiscal policy have been thrown to the winds.
If citing “Bizarroworld” makes you think “Whatever, Boomer,” understand that in the old Superman comics there was a character named Bizarro who was the evil mirror image of Superman himself. Bizarro superficially resembled Superman and the Bizarroworld that he inhabited resembled the “real” world in which Superman fought for truth and justice.
However, everything was twisted and perverse in BizarroWorld. Things were not what they appeared. Outcomes were skewed; the opposite of what should happen happened. Ultimately evil and lies dominated Bizarroworld despite its surface resemblance to the real one.
Not saying the Fed’s anti-coronavirus cut was evil or its motives untrue; but it is bizarre nonetheless.
At first blush, it is yet another example of how public and political perceptions of what exactly central banks can accomplish are divorced from reality, economic history and economic theory. Some players in financial markets, the media, politicians and the general public now apparently assume that these money-regulating institutions can fix all economic woes plus a handful of political and social ones to boot. They cannot do all these things. Assuming that they can is dangerous. It will lead to disaster.
The smart money on Wall Street apparently knows better. The Dow reacted to the Fed’s move with another massive sell-off: down 2.9% Tuesday. The thinking: The Fed must be scared, so we should be too. Not the desired outcome.
Going back a bit in history, by the late 1600s, banks emerged in places like Sweden and England that had some ability to facilitate interactions between smaller retail banks and regulate overall credit.
Situations occurred when a loss of public confidence in financial institutions would cause depositors precipitously to panic, seeking to withdraw their money. But because these banks had made loans, tying up their depositors’ money, they lacked the cash to meet the demanded withdrawals. Without a “lender of last resort” to tide them over, banks would fail and economies would crash. Thus the creation of the central bank. Having such national institutions benefited society as a whole, not just bankers or the wealthy. The U.S. finally got one in 1913 with passage of the Federal Reserve Act.
This all was straightforward in economic theory. There was never any idea that these institutions could cure all economic slumps, let alone deadly diseases, even if they could buffer financial panics. Downturns caused by wars, pestilence, natural disasters or even market crashes are what economists now call “exogenous shocks.” Coronavirus appears to be just such an event.
This limited view of central banking was part of a broader idea that government should stay out of economic activity. “Free markets” were efficient in allocating resources. Government “intervention” or “interference” worsened rather than improved anything.
This view predominated until the 1930s. Then, in reaction to the Great Depression, English economist John Maynard Keynes argued that government should act to correct harmful swings in output, employment and prices. This could be done through fiscal policies -- taxing and spending -- that were up to a parliament or Congress. Central banks could use monetary policy -- money supply and its effect on interest rates -- toward the same ends.
When an economy fell into a recession, the central bank should increase the money supply, thus lowering interest rates. At lower rates, any potential business investment in new plants or equipment would be more financially viable. More such physical investments would be made, jobs created and demand for inputs sustained. Congress and the president would complement cheaper money with lower taxes and more government spending.
There was an opposite situation, that of an unsustainable boom with inflation. Here, the central bank needed to curtail growth of the money supply, thus raising interest rates. More costly credit would slow business investment in physical plants and equipment. Per Keynes, Congress and the president would cooperate by raising taxes and cutting spending.
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This idea, that government could and should manage a nation’s overall economic performance quickly, came to dominate economic theory and the economic policy views of the Democratic Party.
But not all economists became Keynesians. Some clustered around eventual Nobelist Milton Friedman in decrying government micromanagement. Yes, money was important, but it should not be jockeyed in the short term. And trying to control the business cycle with taxing and spending was anathema.
Republicans were split. Some GOP leaders became conservative Keynesians, advocating for small government and low taxes, but accepting that government should, indeed, act to buffer the business cycle. Others maintained adamant opposition to government micromanagement. To them, “Keynesian” was anathema.
Worldwide “stagflation” in the 1970s -- inflation without economic growth -- tainted the allure of Keynesian policies. Younger economists elaborated sophisticated economic theory that came to the same policy conclusions as Friedman’s group. Government micromanagement was not just ineffective, it was harmful. This “rational expectations” school came to dominate the academic economics. It was too esoteric for politicians to expound, but most Republicans shared its conclusions about policy.
In one of the great ironies of history, a financial market bubble that had developed while a Republican, George W. Bush, was in the Oval Office and when the GOP had majorities in Congress, blew apart starting in mid-2007. Suddenly, all the old rules and categories fell apart. Lame-duck Bush 43 essentially went AWOL. Henry Paulson, his treasury secretary, became a hyper-Keynesian, but got little support from his own party in Congress.
The Federal Reserve, whose board of governors was dominated by Bush appointees, initiated a program of near-zero interest rates unprecedented in economic history. Monetarists predicted hyperinflation, which never appeared, at least in consumer prices. The stock market initially collapsed and then began a long rise back to nearly twice its pre-debacle highs.
And that’s where we are today. Stock markets gyrate up and down daily in response to news or rumors. The Fed’s reduction is nearly forgotten as talk has changed to large government spending programs or temporary cuts in taxes, especially FICA payroll taxes.
Back in 2007, many congressional Republicans remained staunchly unchanged, at least in their rhetoric, with Alabama Sen. Richard Shelby solemnly intoning that Obama-nominated Fed Chair Janet Yellen was unfit to replace Bush-named Ben Bernanke because of her dangerous Keynesian views. And once she was chair, Republicans frequently excoriated her for continuing the low-interest rate policy they supported in her Republican predecessor.
So did Donald Trump, who vilified her in his 2016 campaign. Once inaugurated, President Trump did an economic U-turn that gave many whiplash. Soon his appointees, including Jerome Powell as chair, dominated the board -- but Trump continues to tongue-lash the Fed for not pumping out more money to lower interest rates -- the very things he criticized Yellen for.
Now we have a global pandemic. Cruises and air travel are seeing business shrink every day. Schools and public events worldwide are being canceled. Manufacturers who get components from China have slowed production lines. Public confidence has fallen. Factories all over East Asia have shut down because quarantines keep workers home. Global recession, induced by a pure “exogenous shock,” looms.
Stock markets, already in the late stages of a classic bubble, are fibrillating, yo-yoing up and down some 3 or 5 percentage points a day on one bit of news or another. For the first time in a decade, the Fed’s policymaking committee had an unscheduled special meeting to cut its interest rate target by a half-percentage point. Stock prices jump, then fall. February job numbers come in surprisingly strong -- and market indexes fall. Trump remains unsatisfied with the Fed, while his economic advisers talk about tax deferrals for affected sectors.
Few are taking a step back to ask what, exactly, central bank actions like this can do in the face of a pandemic. The answer is precious little. Yes, as after the 9/11 attacks, the Fed can supply liquidity to panicked markets, to sound financial firms suddenly threatened by cash crunches. But a reduction in already-low interest rates in our present situation is not going to motivate companies to build plants or buy equipment. Nor will scared households suddenly slap their credit cards down for discretionary consumer goods like electronics or autos.
The Fed says it is not trying to support stock prices, and I think that’s true. But that certainly is an important factor for a president seeking reelection this year, riding on the success of the economy, and one can understand that many in our country and elsewhere see it as key.
At this point, the Fed has far less relevance than most people believe. Relative to the COVID-19 pandemic, its situation is ironic. If, like SARS in 2003, the disease is contained and fades from view, the Fed’s cut will be unimportant. And if the virus has the enormous impact of the 1918 influenza pandemic, the Fed’s cut will be like mild flatulence during a typhoon. Either way, events are in the saddle and the Open-Market Committee can do little.
We live in challenging and dangerous times. Our policymaking institutions are impotent or incoherent. We are in for a memorable ride.
St. Paul economist and writer Edward Lotterman can be reached at email@example.com.
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