The Fed’s Response to the Coronavirus Doesn’t Go Far Enough

(Bloomberg Opinion) -- Both the Federal Reserve and the White House are considering emergency measures to combat the economic fallout from the coronavirus. These are the right responses, but they don't go far enough.

To be clear, the coronavirus is first and foremost a public-health threat. The full resources of the federal government should be marshaled against it. At the same time, the government shouldn't focus only on public health, and it's wrong to argue that efforts to address the economic effects of the virus are a distraction.

The underlying theory seems to be that there are only two possible outcomes of the coronavirus outbreak. Either the U.S. will adequately address the public health threat, in which case emergency economic measures will not be needed; or the U.S. will fail to prevent a pandemic, in which case they will be useless.

This thinking is mistaken. Yes, if there is a pandemic, the human toll will exceed the economic toll — but the economic toll cannot be ignored. The U.S. would be facing a severe recession, and efforts to mitigate it could help reduce the number of families faced with the double crisis of illness and unemployment.

Besides which, even if the government succeeds in stopping a pandemic, it does not follow that the economy will be fine. The very responses necessary to stem the crisis — quarantines, shutting down workplaces, avoiding crowds, and the like — will take a toll on the economy. There is also the possibility that, even if a pandemic is avoided, pockets of the virus will continue to emerge until an effective vaccine can be developed.

That scenario would create a constant level of fear that is itself depressing to economic growth. Another drag on growth would be the disruption to global trade as the coronavirus spreads to less prepared nations.

All these effects could be enough to push the U.S. into a recession. And once a recession hits, the Fed lacks the tools to easily pull the U.S. out.

The prudent course, then, is to take action now. In 2007, as the global financial crisis was unfolding, the Fed repeatedly relied on half measures until it became clear that the financial sector would fall apart. And the White House's response to the recession was a stimulus that was both inadequate and larded with political favors. Those mistakes should not be repeated.

The Fed should immediately cut interest rates by half a percentage point. It should then prepare both to cut interest rates all the way to zero at its March meeting and to outline the extraordinary measures, such as quantitative easing and yield-curve control, that it is prepared to employ if the crises worsens.

The White House should send an economic aid package to Congress that includes not only the type of payroll and investment tax relief that Republicans support, but also the social spending and state aid that Democrats support. Including spending provisions would serve two functions.

One, it would make the package larger and its impact stronger. Two, it would prevent the package from getting bogged down in partisanship. It would thus avoid a crucial defect of former President Barack Obama's stimulus, which sparked a conservative backlash by failing to include the type of tax cuts that could have earned it Republican support.

It's possible that these measures would be overkill. Even if so, the downside is small. At worst, aggressive aid would overstimulate the economy and produce a little inflation. But inflation has been below target for a decade. A tax cut and spending package would also add to the deficit. But it would create far less debt than a prolonged recession.

The public health response to the coronavirus has to be the government's top priority. Yet an economic response is also necessary. To be effective, it must be swift, sizable and bipartisan. Otherwise, the U.S. risks slipping into another long recession.

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

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

Karl W. Smith, a former assistant professor of economics at the University of North Carolina and founder of the blog Modeled Behavior, is vice president for federal policy at the Tax Foundation.

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