Coronavirus Is An Economic Battle The Federal Reserve Can't Win

This piece was originally published in the Washington Post

The Federal Reserve’s interest rate cut on Tuesday certainly won’t hurt the financial markets or the real economy, but as the subsequent steep drop in stock prices shows, the cut won’t help much, either. Three forces stand in the way.

First, when a country suffers a big shock — from a terrorist attack, a hurricane or a doubling of oil prices — interest rate cuts can encourage businesses and consumers to borrow more money to invest or make large purchases. But that happens only when people believe that the serious effects of the shock are over. That’s why natural disasters don’t upend the overall economy. It’s also why the big interest rate cut in the wake of 9/11 worked: The direct damage was localized, and it wasn’t repeated. In fact, Bureau of Economic Analysis data show that consumer spending grew faster in the quarter immediately following 9/11 than any quarter for more than two years before or after the attack. But when a shock to the economy is more widespread and continuing — as is the case for the coronavirus outbreak — cutting the cost to borrow won’t stop most consumers or businesses from hunkering down.

Second, President Trump has pressured the Fed to cut rates for more than two years, and it has worked — but in a way that he and all of us may come to regret. The Fed reduced interest rates three times in 2019, reversing much of the Fed’s effort from 2017 to 2019 to "normalize" interest rates after many years of near-zero borrowing costs. The result is that now the Fed has much less room to support people’s economic decisions by cutting rates more.

And third, the potential damage from the coronavirus pandemic is in a different league than a half-point or full-point cut in the cost banks pay to borrow funds overnight. It’s true that we do not know how infectious this virus is, so we cannot say yet how quickly it will spread. But at a minimum, not knowing breeds uncertainty, and people and businesses don’t spend freely in uncertain times.

We also don’t know for sure how deadly the virus is, since the data from China has not been very reliable. But if it is deadly to 2 percent of those who catch it, as some epidemiologists have suggested, or worse, lethal to 3.4 percent of those infected, as the World Health Organization now estimates, the results will be tragic.

The economic fallout from this pandemic would be enormous. The disease has already slowed growth in China, South Korea and Japan. All three countries are major U.S. export markets, so as their purchases of U.S. products fall off, unemployment here will begin to rise.

We also import a great deal from them, and half of our imports from China — and a good share from Korea and Japan — are inputs our manufacturers need to make their own products. The tariff war with China has already slowed U.S. production. If the pandemic further slows imports of those inputs, our manufacturing will contract even more, with more unemployment to follow. If the disease broadly affects Europe as well, interest rate cuts will not prevent these cascading costs from jumping.

Economists have also analyzed and speculated about a different class of problems that we could face from a serious pandemic. In 2005, when we faced the threat of avian flu, a number of American and international organizations conducted a war game simulation called "Atlantic Storm" in which bioterrorists spread smallpox in New York, Los Angeles and four European cities. (Madeleine Albright played the U.S. president.) As the game unfolded, it was clear that many of the economic costs came from government officials sealing borders, grounding transportation systems and preventing people from congregating.

If the virus reaches epidemic proportions in the United States without the capacity to test or vaccinate, mayors, governors and the president could well decide to shut down the transport of goods and people across large parts of the country. That could produce widespread economic costs even if the virus isn’t pervasive. If those shutdowns persist for weeks or months and are widespread, everything could slow at the same time — consumption, investment, construction, employment and incomes. Interest rate cuts won’t matter at all.

Coronavirus panic is already driving some Americans to avoid other people — bad news for airlines, theaters, restaurants and sports teams. History suggests that most of us will keep on working until an infection severely affects our own city or town. That also tells us that if the virus spreads across much of the country, a good share of the labor force could stay home, and a large portion of the economy could shut down. Once again, interest rate cuts won’t cut it.