Today’s announcement by the Fed of a 50 bps rate cut – the
first intra-meeting rate cut since 2008 – is an indication of the extent to
which it is taking seriously the potential for corona virus-related economic
disruption. The die was cast yesterday when the OECD reduced its outlook for global growth in 2020 from 2.9% to 2.4% (chart) – just below the 2.5% rate which is considered to be consistent with
global recession. There is little doubt that COVID-19 has left an impression on
the Chinese economy during Q1, with the OECD cutting the 2020 growth projection
from 6.1% to 4.9%, which would be the third slowest growth rate since 1980.
It might yet turn out worse: As the OECD noted, “a longer lasting and more intensive coronavirus outbreak, spreading widely throughout the Asia-Pacific region, Europe and North America, would weaken prospects considerably. In this event, global growth could drop to 1½ per cent in 2020, half the rate projected prior to the virus outbreak.” Markets are certainly looking to the downside, with US equities down almost 3% following the Fed’s actions. So much for shoring up market confidence.
Just to put the coronavirus issue in perspective, the WHO’s latest Situation Report suggests that China has recorded 80304 cases out of a population of 1.428 billion. That’s an infection rate of 0.0056%. Based on the reported number of deaths (2946) this implies that (so far) the chance of an individual dying from the disease is 0.0002%. This is roughly a 1 in 490,000 chance which compares with a 1 in 10,000 chance of being involved in a fatal auto accident in China. Obviously the authorities have put in place some draconian measures to restrict movement which has significantly slowed the rate of new infections but which have had significant adverse consequences for the economy.
But without wishing to downplay the seriousness of the threat posed by the virus, it is important to keep the risks in proportion. Much of what the authorities are preparing for in Europe and the US represents the worst case outcomes and it is important to distinguish these tail risks from outcomes at the centre of the distribution. We have, of course, learned to our cost the failure to prepare for worst case outcomes. The failure to identify tail risks ahead of the Lehman’s bust arguably contributed to the severity of the downturn and on the basis of the old adage, “fail to prepare, prepare to fail” it makes sense to take precautions. If such measures save lives they are clearly worthwhile but we must be careful to avoid talking ourselves into a panic.
The statement by G7 Finance Ministers and central bank governors early today suggested they would “use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.” It was only a matter of hours later that the Fed decided to act. Whilst the G7 was correct to suggest that greater use of fiscal measures was appropriate, it is questionable how useful interest rate cuts will prove to be. This is not to say they are unwelcome but the fact is that many central banks, including the ECB and BoE, have very little scope to cut, unlike in 2008 when there was plenty of downside for rates. This highlights the point that many of us have been making for some years that failure to normalise interest rates as the emergency conditions of 2009 eased, has left many central banks with little policy space to counteract the next downturn.
Moreover, it is widely accepted that the virus will act as a supply shock, as people are unable to work, rather than a demand shock where interest rate cuts can have more of an impact. To the extent that people’s demand patterns are altered, this is more likely to reflect a conscious change in behaviour rather than a response to financial conditions. Where monetary policy can be more effective is in ensuring that business cash flow is not affected by a short-term breakdown in activity. Thus central banks may be able to make more capital available to banks by cutting the countercyclical capital buffer, in a bid to maintain the supply of credit.
On the assumption that the virus effects are relatively short-lived, it is imperative that central banks quickly take back their emergency easing measures in order that they do not become permanent. Fed Chairman Powell sidestepped this question at his press conference today, and whilst it is understandable that he does not want to telegraph the future course of policy, it is equally important for the long-term health of the financial system that markets do not continue to live on the fresh air provided by an overly lax monetary policy. In the event that the ECB cuts rates again, which is a realistic possibility, removing the stimulus as soon as is practicable will help to alleviate some of the damage which negative rates are doing to the fabric of the euro zone banking system.
On the fiscal front, health services will obviously need the resources to ensure that they can function properly and governments are making the right noises to ensure that this will be forthcoming. Another issue which has come to light in recent days is to ensure that there is an adequate form of employee insurance in place. One of the problems for workers, particularly at the low end of the income scale, is that they do not get paid if they do not turn up for work. But if infected people turn up for work in order to collect their pay cheque they run the risk of infecting others. The last thing that hospitals need is for infected porters or cleaning staff to be running around the place. In the UK, those who are self-employed, who account for 15% of total employment, are not entitled to sick pay. Some form of temporary scheme to compensate them for loss of earnings is certainly an option worth considering, even though the practicalities of such a scheme are quite daunting.
But when all is said and done, the best thing the authorities can do to minimise the economic impacts of COVID-19 is to ensure that infection rates are held down. So far as China is concerned, there are hopeful signs that things are improving. The rate at which infections are increasing has not exceeded 2% for the past 9 days as the draconian measures put in place start to take effect. Outside of Hubei Province, the epicentre of the outbreak, there are only 13,000 confirmed cases and just 112 deaths – less than in the rest of the world (166). Prevention is always better than cure but preparedness runs it a close second.
It might yet turn out worse: As the OECD noted, “a longer lasting and more intensive coronavirus outbreak, spreading widely throughout the Asia-Pacific region, Europe and North America, would weaken prospects considerably. In this event, global growth could drop to 1½ per cent in 2020, half the rate projected prior to the virus outbreak.” Markets are certainly looking to the downside, with US equities down almost 3% following the Fed’s actions. So much for shoring up market confidence.
Just to put the coronavirus issue in perspective, the WHO’s latest Situation Report suggests that China has recorded 80304 cases out of a population of 1.428 billion. That’s an infection rate of 0.0056%. Based on the reported number of deaths (2946) this implies that (so far) the chance of an individual dying from the disease is 0.0002%. This is roughly a 1 in 490,000 chance which compares with a 1 in 10,000 chance of being involved in a fatal auto accident in China. Obviously the authorities have put in place some draconian measures to restrict movement which has significantly slowed the rate of new infections but which have had significant adverse consequences for the economy.
But without wishing to downplay the seriousness of the threat posed by the virus, it is important to keep the risks in proportion. Much of what the authorities are preparing for in Europe and the US represents the worst case outcomes and it is important to distinguish these tail risks from outcomes at the centre of the distribution. We have, of course, learned to our cost the failure to prepare for worst case outcomes. The failure to identify tail risks ahead of the Lehman’s bust arguably contributed to the severity of the downturn and on the basis of the old adage, “fail to prepare, prepare to fail” it makes sense to take precautions. If such measures save lives they are clearly worthwhile but we must be careful to avoid talking ourselves into a panic.
The statement by G7 Finance Ministers and central bank governors early today suggested they would “use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.” It was only a matter of hours later that the Fed decided to act. Whilst the G7 was correct to suggest that greater use of fiscal measures was appropriate, it is questionable how useful interest rate cuts will prove to be. This is not to say they are unwelcome but the fact is that many central banks, including the ECB and BoE, have very little scope to cut, unlike in 2008 when there was plenty of downside for rates. This highlights the point that many of us have been making for some years that failure to normalise interest rates as the emergency conditions of 2009 eased, has left many central banks with little policy space to counteract the next downturn.
Moreover, it is widely accepted that the virus will act as a supply shock, as people are unable to work, rather than a demand shock where interest rate cuts can have more of an impact. To the extent that people’s demand patterns are altered, this is more likely to reflect a conscious change in behaviour rather than a response to financial conditions. Where monetary policy can be more effective is in ensuring that business cash flow is not affected by a short-term breakdown in activity. Thus central banks may be able to make more capital available to banks by cutting the countercyclical capital buffer, in a bid to maintain the supply of credit.
On the assumption that the virus effects are relatively short-lived, it is imperative that central banks quickly take back their emergency easing measures in order that they do not become permanent. Fed Chairman Powell sidestepped this question at his press conference today, and whilst it is understandable that he does not want to telegraph the future course of policy, it is equally important for the long-term health of the financial system that markets do not continue to live on the fresh air provided by an overly lax monetary policy. In the event that the ECB cuts rates again, which is a realistic possibility, removing the stimulus as soon as is practicable will help to alleviate some of the damage which negative rates are doing to the fabric of the euro zone banking system.
On the fiscal front, health services will obviously need the resources to ensure that they can function properly and governments are making the right noises to ensure that this will be forthcoming. Another issue which has come to light in recent days is to ensure that there is an adequate form of employee insurance in place. One of the problems for workers, particularly at the low end of the income scale, is that they do not get paid if they do not turn up for work. But if infected people turn up for work in order to collect their pay cheque they run the risk of infecting others. The last thing that hospitals need is for infected porters or cleaning staff to be running around the place. In the UK, those who are self-employed, who account for 15% of total employment, are not entitled to sick pay. Some form of temporary scheme to compensate them for loss of earnings is certainly an option worth considering, even though the practicalities of such a scheme are quite daunting.
But when all is said and done, the best thing the authorities can do to minimise the economic impacts of COVID-19 is to ensure that infection rates are held down. So far as China is concerned, there are hopeful signs that things are improving. The rate at which infections are increasing has not exceeded 2% for the past 9 days as the draconian measures put in place start to take effect. Outside of Hubei Province, the epicentre of the outbreak, there are only 13,000 confirmed cases and just 112 deaths – less than in the rest of the world (166). Prevention is always better than cure but preparedness runs it a close second.
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