Brown on Business

April 6-12, 2020

By Wesley Brown 
wesley@dailydata.com

 

Economist struggle forecasting how to reboot economy after COVID-19 threat passes

 

As the shock of the COVID-19 crisis wears off and Arkansas and the rest of the nation settle into a possible long hibernation, some economists are having difficulty trying to forecast how to get the U.S. economy out of a pandemic-induced recession.

 

Before the respiratory illness formerly known as 2019-nCoV began spreading across the U.S. with unprecedented speed, most U.S. economists were making busy making predictions on whether the Federal Reserve could land the nation’s economy softly enough without causing a major contraction.

 

Known in economic forecasting circles as a soft landing, the process of shifting the economy from strong to slow to potentially flat GDP growth while avoiding a recession is sort of the “holy grail” for the nation’s central bank. It is usually attempted by Federal Reserve’s in their efforts to holding inflation around 2% by raising interest rates for several cycles. 

 

According to Investopedia, the concept was first conceived and achieved by Alan Greenspan, former chairman of the Federal Reserve. The longtime Fed chief who served under four presidents apparently engineered the only true soft landing in U.S. history in 1994-95, when the Fed raised interest rates enough to slow the economy, but not enough to cause GDP growth to contract.

 

About the same time the first known positive coronavirus case in Wuhan, China was reported in late January, some economists were applauding current Fed Chairman Jerome Powell for bringing the world’s largest economy in for a “so-called” soft landing. 

 

After two earlier attempts following the $1.8 trillion stimulus package in late 2017 pushed U.S. Gross Domestic Product over 3% for several months in the following year, Powell was near to landing on the U.S. economy on a smooth runway after adopting the Fed’s accommodative policy of gradual rate hikes in the fourth quarter after frequent complaints from President Donald Trump.

 

In a presentation in late January before the Wisconsin Bankers Association, St. Louis Fed President and CEO James Bullard said that Federal Open Market Committee (FOMC) led by Powell acted in 2019 to help ensure a soft landing by dramatically altering the path of monetary policy.

 

Bullard said that a slowdown in U.S. GDP was widely expected because the economy tends to return to its potential growth rate. The key risk in 2019, he said, was that a downturn would be sharper than anticipated and cause the economy to crash land and enter a recession.

 

In the summer of 2019, the FOMC indicated that a lower policy rate might be warranted. The 12-member Fed panel that includes seven Fed governors and five of the 12 Fed district presidents then made reductions in policy rate at three successive meetings, ending with a net reduction of 75 basis points in the federal funds rate in October.

 

“The FOMC’s adjustment toward lower rates in 2019 may help facilitate somewhat faster growth in 2020 than what might have otherwise occurred,” Bullard said during his speech to the Wisconsin bankers. “One could view this as insurance against the possibility that nonmonetary factors could have larger-than-expected negative effects on growth.”

 

Bullard also noted possible downside risks to the Fed’s accommodative policy, including uncertainty sparked by the Trump administration’s ongoing trade war with China, financial market exuberance and resurgent geopolitical risk, such as fight between Russia and OPEC to control international crude oil prices.

 

“The FOMC has a reasonable chance of achieving a soft landing for the U.S. economy in 2020 following a large adjustment to monetary policy during 2019,” concluded Bullard, who oversees one of 12 Fed districts that includes Arkansas and six other states.

 

A month later during a speech at the Fort Smith Regional Chamber of Commerce as the coronavirus was spreading quickly across the U.S., the St. Louis Fed chief was still holding to his belief that U.S. monetary policy during 2019 that was designed in part to insure the economy against possible negative shocks to growth.

 

“This [policy] has put the FOMC in a good position in early 2020 as we closely monitor the evolving coronavirus impact on the global economy,” said Bullard.

 

However, what Bullard, the Federal Reserve and other top economists could have never imagined was the near total shutdown of the U.S. economy due to something called “social distancing,” leading to another the passage of another stimulus package to the tune of $2.2 trillion. 

 

Considering these developments, the FOMC decided in early March to lower the target interest rate for the federal funds from 0.25% to zero percent. And to support the “smooth functioning” of financial central to the flow of credit to households and businesses, the Fed also upped its holdings of both U.S. debt and mortgage-backed securities by $700 billion. 

 

“The Federal Reserve is committed to use its full range of tools to support the U.S. economy in this challenging time and thereby promote its maximum employment and price stability goals,” Fed Chief Powell said in a March 23 statement addressing strains in the market for Treasury debt and mortgage-backed securities.

 

What may even be harder to predict is how to revive the world’s largest economy once the coronavirus threat has passed and American consumers are not fearful of getting back to the norm of buying groceries in an overcrowded Walmart, purchasing new cars and participating in an open house to buy or sell a new home.

 

In a March 25 research note, the influential Conference Board offered three scenarios for the nation’s economic bounce bank. They are titled the May Reboot, the Summertime V-Shape contraction, and the Fall recovery. 

 

The May reboot, or quick recovery, assumes a peak in new COVID-19 cases for the US by mid-April, followed by economic activity gradually resuming in May. The Summertime V-shape downturn predicts that new COVID-19 cases will be higher and delayed until May, creating a larger economic contraction in second quarter that will be followed by a stronger recovery in third quarter. 

 

The fall recovery scenario proposes an extended recession with managed control of the COVID-10 outbreak that helps to flatten the curve of new cases and stretches the economic impact across most of the summer with growth resuming by September.

 

Regardless of the scenario, the Conference Board’s economists Bart van Ark and Erik Lundh said the current national policy of social distancing due will lead the U.S. economy into a recession for an extended period. “Recessions are often triggered by an unexpected event, and that is certainly true for what may go down in history as the ‘Coronavirus Recession,’” wrote the chief and senior economists for the global business and economic research think tank.

 

Lundh and van Ark also said whatever the degree of economic contraction and the shape of the recovery, the level of economic activity by the end of the 2020 in all scenarios will be lower than it was at the end of 2019 by between 1.6% and 6%.

 

“Contractions of this kind on either a quarterly or annual basis have not been seen since the aftermath of WWII,” said the Conference Board forecasters. 

 

  • Wesley Brown
    Wesley Brown