NEW YORK (Reuters Breakingviews) - When planning the financial equivalent of the D-Day invasion, it’s best not to pinch pennies. The U.S. Federal Reserve said on Monday that it’s ready to buy virtually unlimited amounts of government-related debt and some corporate bonds, and offer other measures to keep credit flowing as the coronavirus-triggered economic crisis intensifies. But once the country is on the other side, Fed Chair Jerome Powell and his colleagues need to rethink their policy tool kit.
The blunderbuss approach is the right one. The United States, like other countries, is facing economic Armageddon, with analysts predicting huge downturns in economic activity in the second quarter. Sure, predictions about the impact of a pandemic involving a novel virus are unlikely to be accurate, but all of them are shockingly bleak. So the Fed has to do what it can, even if other parts of government can’t get their acts together.
Yet the Fed’s actions will have consequences. In response to the 2008 financial crisis, the central bank slashed interest rates to near zero and bought bonds by the trillions, among other measures. This helped keep a depression at bay, but it also led non-financial companies to pile on debt. At year-end, the total was near 50% of GDP, above the 2008 peak. This makes companies vulnerable if debt costs increase, as they recently have. And then there’s the government’s own debt burden. That has ballooned to over 100% of GDP and is about to get bigger.
Low rates have made this situation seem sustainable, and that’s part of the problem. Sure, the economically stable level of interest rates is probably lower than it used to be. But ultra-cheap money creates a vicious cycle, reducing the ability of a central bank to increase rates without causing ever-heavier damage and so biasing policymakers toward keeping them low.
That’s been the story since the crisis, and it can make it tougher to generate adequate safe returns for an aging population and avoid creating asset-price bubbles. It also leaves less fuel to fight inflation if it ever reappears.
In a post-Covid-19 world, globalization could be curtailed, the dollar’s dominant reserve status could be challenged, and fiscal policy could become looser. Either deflation or runaway inflation could emerge. The last decade’s playbook won’t be of much use – the Fed may need a new one.
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