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Business Faculty Comment on Coronavirus

Business Faculty Comment on Coronavirus

On Tuesday, March 3, the US Fed announced an emergency rate cut in response to the continued spread of the coronavirus (COVID-19). Below, three School of Business faculty members weigh in on the cut’s impact.


Dr. Seung Hee Choi, Chair & Professor, Finance

The Federal Reserve cut its benchmark interest rate by 50 bps to support the economy. The G-7 also issued a statement that, given the potential impacts of COVID-19 on global economy, they reaffirmed their commitment to use “all appropriate policy tools” to achieve strong, sustainable growth. Policy makers globally can be expected to provide both monetary and fiscal support given that the current economic disruption caused by COVID-19 will weigh on economic activity of both households and businesses. The swift downturn in commodities could ease inflationary pressures and provide more room for further easing. In the event where COVID-19 causes long-term negative economic impacts, the Fed will have to consider different policy tools.

 

Dr. Michele Naples, Professor, Economics

There were several signs that the economy was heading to recession before the coronavirus hit. Real investment slipped 3% from Q1 to Q4 2019, and there has been deflation in producer prices by 2.5% since Oct. 2018. Falling prices make it harder for those producers to repay their debt. Last August the yield curve inverted, and in September there was a liquidity crunch in the Repo market (where bonds are temporarily loaned), both of which herald a coming recession. Since then, the Fed has expanded the money supply $60 billion/month to supply the Repo market with liquidity, even before dropping the federal-fund interest rate target again yesterday.

The coronavirus comes at a bad time in the business cycle, insofar as there are already these indications of a slowdown and likely downturn. When towns and national governments close factories in China or Italy, there are known supply-chain disruptions. You cannot make a car when the parts don’t arrive, because the parts-factory is closed. However, there is also great uncertainty as to what the health and economic toll will be from the sickness. This helps explain the 11-12% slip in stock prices last week. Remember, in 1987, stocks fell 22% in one day in a crisis of confidence. Last week’s reaction was not as large, and more gradual.

Deaths from the coronavirus appear most likely for those over 30 and with compromised immunity or lungs. China has a much higher smoker rate than the US (52% of men, 3% of women vs. 17% and 14% in the US), and higher pollution levels, both of which impair lungs. Americans may better withstand the extreme consequences of the virus. If the US can refrain from overreacting to the threat and not shut down economic activity, and people can follow CDC recommendations to call for medical help rather than showing up in emergency rooms and spreading the virus, we will weather the public-health challenge and the economic damage will be less.

Dr. Trevor O’Grady, Assistant Professor, Economics

For the most part, economists think markets and other decentralized interactions do a pretty good job of producing favorable societal outcomes when left to their own devices. There are exceptions of course, and there is a fair amount of disagreement within our field about when these exceptions warrant government intervention. I would hazard a guess, however, that intervening to stem an outbreak of an infectious disease is among the least controversial. With respect to the spread of COVID-19 virus, it would be unrealistic to expect markets, social norms, and self-restraint alone to be enough to account for the spillovers individual actions (like washing your hands regularly for 20 seconds at a time) have on millions of others. In this case, governments can increase aggregate welfare by constraining choices (e.g. travel restrictions, mandatory quarantine periods) and through public spending (e.g. funding research for potential vaccines).

The Fed’s recent interest rate cut was an intervention in response to COVID-19, but was not intended to combat the disease itself or its direct effects, but rather the potential ripple effects it may cause. In our highly interconnected economy, having stable economic activity is quite valuable and we know things can sour quickly. Rate cuts will not reopen factories in China, but they will make spending relatively more attractive (compared to saving) which can increase economic activity to help stave off a broader chain reaction from the slowdown.

To be sure, there are downsides to rate cuts. Interest rates cannot get much lower and the Fed now has less ability to buffer future shocks. But like before, I believe this is a case in which most economists would find the Fed’s emergency intervention to be justified. If not now, then when? Perhaps a more interesting and controversial question is whether it was wise for the Fed to keep interest rates low throughout this long and relatively virus-free economic expansion we have been enjoying. Here I think you will find more disagreement among my colleagues and me.

 

 

 

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