Driven by opportunism, intellectual inertia and a need for comfort, people often respond to novel and unsettling problems by reverting to the old, familiar rallying cries. Politicians, especially, decide that the thing they always wanted is more important than ever. Rep. Lee Zeldin, a New York Republican, succumbed to this temptation when he argued that lifting the cap on the deduction for state and local taxes should be part of the response to the coronavirus. It would be a timely idea if COVID-19 targeted affluent households in high-tax states.
Advocates of a new monetary regime are in a slightly different position, because many of them have been urging new policies to deal with the kind of situation we are now in. They didn't foresee this virus, of course, but they did warn that the Federal Reserve might have to respond to an economy falling into recession with interest rates already low. Under those circumstances, the Fed would not be able to provide much help in the standard way, by lowering rates further.
Some people therefore advocated that the central bank should raise its inflation target from 2% to 4%. If inflation were 2% higher, then nominal interest rates would be, too, and there would be more room to cut them. Others advocated more radical steps, such as moving away from paper currency to enable negative interest rates.
Another idea, advocated in this space, was for the Fed to drop its inflation target and instead aim for total dollar spending in the U.S. to grow by 4.5% a year. Just as important, the Fed would commit to correcting for undershooting the target in one year by overshooting it the next, and vice versa, to keep the long-term growth of spending on track. By reducing the likelihood of a prolonged depression, this commitment to making up for past mistakes would raise market interest rates. It would thus, like the other ideas, give the central bank more room to maneuver.
Had the Fed followed this type of policy over the last few years, interest rates and inflation would be higher now, and it would be possible to reduce real interest rates more sharply. Reducing interest rates isn't a panacea: It can't conjure up a vaccine or repair supply chains or make people feel safe to travel. Its value is in ameliorating the consequences of a fall in spending, such as unexpectedly rising mortgage burdens for homeowners and per-employee costs for companies. If our main economic problem now consisted of supply-chain disruptions, inflation expectations would be rising. Instead they have been plummeting.
Since the Fed sadly lacks access to a time machine, it cannot go back and change its policies over the last few years. But there are several things it can do. It should immediately move the federal funds rate and the interest rate on excess reserves to zero.
The Fed has, understandably but consistently, been behind the curve. (President Donald Trump is right about that.) The key way it can stabilize the economy is by clarifying that it is willing to do what it takes to maintain spending levels, at least over the medium term, and will not be overly cautious. The Fed does not have much room to cut rates, just as the worriers predicted it wouldn't. But it also hasn't used the room it has.
It can and should also provide aggressive forward guidance, explaining that rates won't rise again until spending, or at least prices, are back on track. And it should commit to making asset purchases as needed to hit these targets. In short, the Fed should move as much as it can toward a spending target even in the midst of this crisis — or, rather, especially in its midst.
If these steps are not sufficient to stabilize expectations for inflation and spending, then it will mean that the Fed's existing tools do not give it sufficient credibility, and it will have to ask Congress for more, such as the ability to buy different types of assets or inject new money into the economy via "helicopter drops."
The coronavirus will keep employment, output, wages and stock prices lower for the year than they otherwise would have been (thinking of the last three in inflation-adjusted terms.) Neither the Fed nor anyone else can prevent these effects. As with the virus itself, the current imperative regarding its economic fallout is mitigation. Congress and the president will have to do some of that work via Medicaid payments, unemployment insurance and the like. But much of that work has to be done by the Fed, and quickly.
Changing monetary policy in this way will help us recover from the hit we are currently taking. Even better, it will help ensure that we are better equipped for any economic downturn a few years from now.
Ramesh Ponnuru is a Bloomberg View columnist. He is a senior editor of National Review and the author of "The Party of Death: The Democrats, the Media, the Courts, and the Disregard for Human Life." To read more of his reports — Click Here Now.
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