The Federal Reserve’s 50-basis points rate cut on Tuesday had a whiff of the dark days of the financial crisis. It was the biggest since 2009 and the first to take place in between normal meetings since 2008. It similarly underlined the decisiveness of the Fed compared to its peers: the move sends a strong signal — the rate-setting committee was unanimous — that it will not hesitate to do what it can to contain the economic repercussions of the coronavirus.
The Fed chose to act despite questions over how much rate cuts can really do. Economists point out that monetary policy cannot address the supply shock of people falling ill and being unable to travel or work. Fed chair Jay Powell said himself that a rate cut will not “reduce the rate of infection or fix a broken supply chain”.
This may be why stocks reacted more with a wobble than with euphoria. Equity prices first surged then fell, suggesting some investors took the Fed move as a sign of the extent of the economic damage to come. Echoes of the financial crisis are not reassuring.
Yet the Fed has seen the insurance value of prompt action. Even if the epidemiological developments are beyond its control, the financial repercussions — especially broader confidence and expectations in the economy — are not. As Mr Powell said, a rate cut should go some way towards offsetting any retrenchment in consumption and investment from fearful households and businesses.
Just as important is what the Fed is leading these constituencies, and markets, to expect. Mr Powell is letting the economy know that when things get rocky, he is ready to act. This reduces uncertainty around the strength of the policy response. As the financial crisis showed, if fear takes hold in credit markets and business financing seizes up, a forceful monetary response is vital.
Other than the risk of spooking markets, there were few downsides to acting swiftly. The global economy is already shaky and inflation below the central bank’s 2 per cent target; The Fed’s preferred measure hit 1.6 per cent in January. The dangers of excessive caution were greater than those of being trigger-happy.
Yet the Fed must be careful not to look panicked, or as if it is being led by markets. Members of its board gave no hint that they were thinking of cutting rates in remarks last week. Stocks fell further as Mr Powell explained the central banks’ reasoning, as investors found his logic unconvincing. The Fed chair insisted US economic fundamentals remained strong, but coronavirus posed “evolving risks” to sectors such as manufacturing, travel and hotels.
Other central banks must now decide whether to follow. The Fed’s move came swiftly after a communique from the G7 economies that vowed to take appropriate measures but fell short of co-ordinated action. Markets and economists were disappointed by a statement that largely repeated previous comments. The last time the Fed cut rates by 50 bps it was in concert with other central banks. This time it moved alone.
That may reflect the fact that other countries already have far lower interest rates. The value of the European Central Bank taking interest rates deeper into negative territory is questionable. Still, the ECB has other options available including targeted measures aimed at small businesses.
The world’s capacity for multilateral action has also been eroded since the financial crisis. It would be useful if the Fed’s decision served to encourage the Trump administration, and other governments around the world, to take the epidemic as seriously as America’s central bank does.
