Congress Has an $8 Billion Plan for Coronavirus. It's Not Enough.

(Bloomberg Opinion) -- On Tuesday, following the advice of many outside commentators (including me), the Federal Reserve responded to the turmoil and risks caused by the coronavirus by cutting interest rates in a highly unusual intermeeting move. That's a good start, but the Fed must do more. And if it is to be successful in stabilizing the economy and markets, it needs help from its congressional overseers.

Today, Congress agreed to fund a $7.8 billion response to the outbreak. But this is a small drop in what is likely to be a big bucket. Congress must do a lot more.

The (immediate) market response to Tuesday's Fed action was not gratifying. Equities slid by another 3%. Worse, long-term bond yields continued to fall. At the beginning of 2020, when the world first began learning about the virus now known as Covid-19, the 30-year Treasury bond yield was already near historical lows, at less than 2.4%. It is now below 1.7%. These low yields suggest that the novel coronavirus — and the policy response to it — is driving down investor confidence in growth and inflation through 2050.

This lack of confidence in the future is itself a big drag on the willingness of households to spend and businesses to invest — possibly bigger than the drag generated by the coronavirus itself.

So, what should the Fed do next? 

In answering this question, it's essential to understand the nature of the shock to the economy.  Many observers have emphasized the adverse impact of the virus on supply (especially in the global chains that play such a crucial role in manufacturing). The shock obviously has a supply element. But it seems clear that much of the impact of the virus is in the form of uncertainty, as households and businesses struggle with the question of where the disease will hit next, and how bad it will be when it does hit. This uncertainty is a drag on demand in the many communities throughout the country and world that have no cases of the virus. But that drag can be offset, as usual, by stimulus from the Fed and other policy makers.

But how can you tell I'm right, as opposed to those commentators who emphasize supply?  Well, the expectations for inflation over the next five years priced into the spread between conventional Treasuries and inflation-indexed Treasuries have plummeted since January. That's the imprint of a demand shock, not a supply shock.

Given the demand nature of the shock, the Fed can and should do more when it meets again in a couple of weeks. But the market response to the rate cut sent a clear message: Investors don't believe that the Fed has sufficient ammunition, on its own, to support inflation and growth at appropriate levels. This doubt is not about the next year or two, but rather about the next decade or three.

Congress has to step up to show its willingness to systematically insulate the economy against aggregate demand shocks by, for example, using a combination of tax cuts and increases in infrastructure spending. Without a much clearer strategic commitment to fiscal policy support of the economy, we can expect further declines in long-run expectations about growth and inflation — and that will make the current aggregate demand shortfall even worse.

To contact the editor responsible for this story: Sarah Green Carmichael at sgreencarmic@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Narayana Kocherlakota is a Bloomberg Opinion columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.

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