Fed gambled — and lost

The Federal Reserve’s first attempt to stabilise the US economy in the face of the threat from the coronavirus seems to have failed. On March 3, the Federal Open Market Committee (FOMC) decided to cut the so-called fed funds interest rate by 50 basis points, from a range of 1.5% to 1.75% to a new range of 1% to 1.25%.
By acting decisively, the Fed apparently hoped to bolster confidence and to stabilise an economy that has been weakened by the coronavirus. It seemed an opportune moment to strike, because the stock market had rallied the day before. Last week, the Dow Jones Industrial Average rose 5.1%, or 1293.6 points. This offset about a third of the losses suffered in the previous seven trading sessions.
So the Fed gambled—and lost. The interest rate cut was announced on March 04, and the market started to decline almost immediately. The Dow ended the day down 785.91 points, about 2.9%. The Standard & Poor’s 500 was off 2.8%, and the Nasdaq dropped 3%.
Just how the Fed’s interest-rate cut might stimulate the US economy is unclear. Normally, when the Fed reduces the fed funds rate (fed funds are short-term loans usually among banks), it’s assumed that rates on home mortgages, corporate bonds and car loans also drop. But these rates are already low. If people won’t eat out because they might contract a virus, will a half a percentage point on a loan convince them otherwise?
At a press briefing, a
reporter asked “what changed between last week when many of your [Fed] colleagues seemed to indicate [that] it was still too soon to tell how this [virus] might influence the outlook … and today?”
Powell responded that “we have been carefully monitoring the situation….[and] we have come to the view now that it is time for us to act in support of the economy, and once you reach that decision, we decided to go ahead.” There are more reports of trips being cancelled, people shunning restaurants and factories running out of
essential parts.
The simplest explanations for the market’s decline are that investors and traders are scared, fearing that the economic setbacks may be worse than expected.
In a report issued last week, the Organization for Economic Cooperation and Development (OECD) — a group of advanced countries — cut its forecast for growth of the global economy in 2020 to 2.4%, down 0.5 percentage points from a prediction made in November. It warned that the economic slump could get worse.
The slump is clearly global in nature, with China as the epicenter. “The global economy has become substantially more interconnected,” the OECD said. In 2002, China’s economy was equal to 6% of the world economy; by 2019, it was 17%.
This means that when China’s troubles spread abroad, they have a bigger impact. China’s tourists, for example, account for about a tenth of all cross-border visitors, according to the OECD. They are also one quarter or more of visitors to Japan and South Korea. When they stay home — because they’re quarantined, or cautious — the impact is global.
Whatever happens, the Fed is almost certainly not finished with lower interest rates. The next meeting of the FOMC is scheduled for March 17 to 18.

—The Washington Post

Robert J. Samuelson is a journalist for The Washington Post, where he has written about business and economic issues since 1977. He was a columnist for Newsweek magazine from 1984 to 201