Economists: contextualize and rationalize the latest Covid-related news?
March 15, 2020 10:03 PM Subscribe
I have only taken elementary economics courses, so my understanding of the latest developments in the US with the fed cutting rates is only surface-level. But the recent decision for the fed to further cut rates already seems drastic and quite scary. I'm hoping someone with an economics background can provide some context.
First off, I don't want to come off as someone who is worrying solely about the economy - I've been following the crisis as it relates to health and the virus directly, and I'm quite scared of how the next few months will play out. But this evening, I began reading about the fed's decision to cut rates further, and many economists in the media seem to be signalling this is a very bad sign. While the health effects are going to be devastating internationally, it seems the economic impacts of the virus and the economic decisions being made could be catastrophic for years beyond the effect of the virus.
I can't tell to what extent the media is being sensationalist due to the unknown nature of the virus (we don't know if this will be a disruption of a few months, a year, etc.) or whether the decisions that are being made by the government economically are pre-determining a recession or even a depression (yes, I have seen a lot of comments going so far as saying that we could be looking at a very difficult economic decade similar to the great depression).
I guess I'm just wondering - how do people who have a decent grasp of how macroeconomics (in the US context) works view the current news?
First off, I don't want to come off as someone who is worrying solely about the economy - I've been following the crisis as it relates to health and the virus directly, and I'm quite scared of how the next few months will play out. But this evening, I began reading about the fed's decision to cut rates further, and many economists in the media seem to be signalling this is a very bad sign. While the health effects are going to be devastating internationally, it seems the economic impacts of the virus and the economic decisions being made could be catastrophic for years beyond the effect of the virus.
I can't tell to what extent the media is being sensationalist due to the unknown nature of the virus (we don't know if this will be a disruption of a few months, a year, etc.) or whether the decisions that are being made by the government economically are pre-determining a recession or even a depression (yes, I have seen a lot of comments going so far as saying that we could be looking at a very difficult economic decade similar to the great depression).
I guess I'm just wondering - how do people who have a decent grasp of how macroeconomics (in the US context) works view the current news?
There's nothing to really compare this too. Workplaces are shutting down, which is going to reduce goods actually made (and thus reduce demand.) Trade and supply chains will be disrupted. It's hard to say what the effect will be other than "negative".
The Fed cutting rates to zero is a sign that the Fed is worried about stuff. Unlike the 2008 financial crisis, rates and the stock market will be secondary to the the real world impact I think.
Price / Earning ratio is still higher than it's ever been.
The P/E ratio for the S&P 500 seems to be around 16-17, which is in line with the historical average.
posted by mark k at 11:47 PM on March 15, 2020 [1 favorite]
The Fed cutting rates to zero is a sign that the Fed is worried about stuff. Unlike the 2008 financial crisis, rates and the stock market will be secondary to the the real world impact I think.
Price / Earning ratio is still higher than it's ever been.
The P/E ratio for the S&P 500 seems to be around 16-17, which is in line with the historical average.
posted by mark k at 11:47 PM on March 15, 2020 [1 favorite]
IMHO, the problems and the solutions are not in the financial markets. They just reflect what's happening out where GDP is created. There is a fundamental risk in the modern economy because so much of the economy is discretionary spending which can be turned off in an instant. We see that now in the travel and hospitality sectors. FWIW (not much), I expect the stock market to continue to fall until and unless we see at least a hint the the rate of new infections is slowed.
The US Congress has bailed out the airline's at least twice, after SARS and after 9/11. It's not going to help your local diner or the car dealer who hasn't sold a car in two months.
posted by SemiSalt at 5:23 AM on March 16, 2020 [6 favorites]
The US Congress has bailed out the airline's at least twice, after SARS and after 9/11. It's not going to help your local diner or the car dealer who hasn't sold a car in two months.
posted by SemiSalt at 5:23 AM on March 16, 2020 [6 favorites]
I agree with SemiSalt and would add, which might clarify, the last recession was at heart a problem with bad loans and so in infusion of cash and lowering interest rates by the Fed were important things. The Covid-19 pandemic is causing a sudden cut in consumer confidence and spending, a sudden cut in demand. The size and rapidity of the cut are unprecedented.
This economy---longest US boom market ever although in the recent period many other Western economies teetering---may have some underlying issues as Dum Spiro Spero (South Carolina!) recounted that the Covid-19 closures will worsen and expose.
It's been many years since I had micro and macro econ classes, but this seems like the perfect storm for the world economy. And with the triggering cause being a pandemic, economists may have little historical precedence at their mental fingertips.
The question which would be most helpful to know is unanswerable: how long will this last?
I don't doubt that Covid-19 is a real worry. When the news first came out of China I decided to read a history of the so-called Spanish Flu Pandemic of 1918. Didn't make me feel better about the challenges the world is facing now.
posted by tmdonahue at 6:22 AM on March 16, 2020
This economy---longest US boom market ever although in the recent period many other Western economies teetering---may have some underlying issues as Dum Spiro Spero (South Carolina!) recounted that the Covid-19 closures will worsen and expose.
It's been many years since I had micro and macro econ classes, but this seems like the perfect storm for the world economy. And with the triggering cause being a pandemic, economists may have little historical precedence at their mental fingertips.
The question which would be most helpful to know is unanswerable: how long will this last?
I don't doubt that Covid-19 is a real worry. When the news first came out of China I decided to read a history of the so-called Spanish Flu Pandemic of 1918. Didn't make me feel better about the challenges the world is facing now.
posted by tmdonahue at 6:22 AM on March 16, 2020
Brief thoughts from Greg Mankiw, a leading Republican economist, which have been endorsed by Democratic economists:
- A recession is likely and perhaps optimal (not in the sense of desirable but in the sense of the best we can do under the circumstances).
- Mitigating the health crisis is the first priority. Give Dr. Fauci anything he asks for.
- Fiscal policymakers should focus not on aggregate demand but on social insurance. Financial planners tell people to have six months of living expenses in an emergency fund. Sadly, many people do not. Considering the difficulty of identifying the truly needy and the problems inherent in trying to do so, sending every American a $1000 check asap would be a good start. A payroll tax cut makes little sense in this circumstance, because it does nothing for those who can't work.
- There are times to worry about the growing government debt. This is not one of them.
- Externalities abound. Helping people over their current economic difficulties may keep more people at home, reducing the spread of the virus. In other words, there are efficiency as well as equity arguments for social insurance.
- Monetary policy should focus on maintaining liquidity. The Fed's role in setting interest rates is less important than its role as the lender of last resort. If the Fed thinks that its hands are excessively tied in this regard by Dodd-Frank rules, Congress should untie them quickly.
- President Trump should shut-the-hell-up. He should defer to those who know what they are talking about. Sadly, this is unlikely to occur.
Two points to add:
The drastic Fed action is good in real terms, in that it should partially mitigate the damage. But it is a bad signal: The fact that the Fed thinks it is necessary means that the situation is worse than some people might have thought, which is why the markets (last I checked) seems to be reacting badly.
An economic slowdown is painful but necessary medicine - perhaps analogous to putting a patient in a medically-induced coma to allow her to heal. If the economy kept on humming as usual, with all the human interaction that requires, many more people would die. That's not to minimize the human suffering that will stem from the slowdown, but that is the lesser of two (very great) evils.
posted by Mr.Know-it-some at 7:00 AM on March 16, 2020 [2 favorites]
- A recession is likely and perhaps optimal (not in the sense of desirable but in the sense of the best we can do under the circumstances).
- Mitigating the health crisis is the first priority. Give Dr. Fauci anything he asks for.
- Fiscal policymakers should focus not on aggregate demand but on social insurance. Financial planners tell people to have six months of living expenses in an emergency fund. Sadly, many people do not. Considering the difficulty of identifying the truly needy and the problems inherent in trying to do so, sending every American a $1000 check asap would be a good start. A payroll tax cut makes little sense in this circumstance, because it does nothing for those who can't work.
- There are times to worry about the growing government debt. This is not one of them.
- Externalities abound. Helping people over their current economic difficulties may keep more people at home, reducing the spread of the virus. In other words, there are efficiency as well as equity arguments for social insurance.
- Monetary policy should focus on maintaining liquidity. The Fed's role in setting interest rates is less important than its role as the lender of last resort. If the Fed thinks that its hands are excessively tied in this regard by Dodd-Frank rules, Congress should untie them quickly.
- President Trump should shut-the-hell-up. He should defer to those who know what they are talking about. Sadly, this is unlikely to occur.
Two points to add:
The drastic Fed action is good in real terms, in that it should partially mitigate the damage. But it is a bad signal: The fact that the Fed thinks it is necessary means that the situation is worse than some people might have thought, which is why the markets (last I checked) seems to be reacting badly.
An economic slowdown is painful but necessary medicine - perhaps analogous to putting a patient in a medically-induced coma to allow her to heal. If the economy kept on humming as usual, with all the human interaction that requires, many more people would die. That's not to minimize the human suffering that will stem from the slowdown, but that is the lesser of two (very great) evils.
posted by Mr.Know-it-some at 7:00 AM on March 16, 2020 [2 favorites]
To give some context for what the Fed's policy is normally trying to do and what Mankiw's saying in his second-to-last-bullet (I don't disagree, in general, with anything he's saying):
Monetary policy works through a number of channels, but essentially what the Fed typically does is affect the interest rate at which banks lend to each other on a short-term ("overnight") basis. They have several tools for doing this -- they have mechanisms that tend to put a ceiling or a floor on those interest rates, and the trading desk at the New York Fed will buy and sell treasury bonds to affect the quantity of bank reserves banks hold (essentially, adjusting the supply of bank reserves in order to keep the price in the range the Fed would like).
Other interest rates tend to follow movements in interbank rates. The Fed lowering rates, through various channels, tends to stimulate investment activity -- when it's cheaper to borrow, more people are willing an able to do it. This tends to reverberate throughout the economy -- the people hired to build new houses might spend more, etc, etc. Broadly, we could label this "aggregate demand management" -- trying to affect the final demand for goods and services, holding fixed the ability of the economy to supply those goods.
Many recessions are characterized by a shortfall in aggregate demand. What's occurring right now has some flavors of that -- people can't work so they can't spend as much, or they're nervous so they don't go out to eat, or maybe hold off on buying a new house, etc. If that were the only problem, then what the Fed's doing would probably ease some of that pressure -- at the margin, some folks who wouldn't be interested in buying a car right now might be because auto loan rates are lower. Whether the Fed's dramatic actions would be enough to completely avoid a recession is another story, but it would be pushing against the general shortfall in aggregate demand.
But there's also a supply side shortfall here -- activity is slowing because people can't get to work. The Fed can't really influence that, or affect supply chain disruptions directly -- at the end of the day, they own a very powerful printing press that they are legally permitted to use for particular purposes.
So what are they doing? They're trying to make sure that the disruptions they can't control don't create other problems they'd like to avoid. For example, stocks are falling for all sorts of reasons right now, but one is surely because of the general macroeconomic implications of COVID-19. The Fed can't create a vaccine, but it's trying to make sure that that financial fallout doesn't, say, turn into a general financial panic. Their concern is that, say, banks that would normally be able to weather this will suddenly be in trouble because everyone's unsure about whether the financial system is going to 'work.' So the Fed's moves in the past couple of weeks are essentially about making sure there's enough money floating around the financial system so that its normal functions continue. (E.g., many firms issue short-term debt to issue paychecks, and the Fed wants to make sure that they can find a lender). As long as the Fed credibly promises that it will provide that liquidity -- acting as a lender of last resort, even if you can't borrow from another bank, you can borrow from the Fed -- then the financial system won't be exacerbating any recession that occurs.
Why are economists interpreting this as a "bad sign?" Well, there's a couple of things. One is if they think the Fed has some informational advantage -- they know something markets (or the public) hasn't realized yet about how bad things are going to get economically. So we see the Fed acting dramatically, and say 'wow, what a bad sign, time to cash out and hide in the woods.' Another problem is that, since the last crisis, the Fed's ability to lower interest rates has been limited -- for practical reasons, it's hard to lower the nominal rate it targets below zero. So as of today, the Fed is going to have to go back to the financial crisis playbook in terms of trying to figure out a way of influencing the economy and financial markets, because they can't lower the fed funds rate any further. That may also be making market participants nervous. (To the Fed's credit, they have been thinking about this since the last crisis; there's been lots of discussion among policy economists about the high probability of recurring ZLB events in the future because of a general decline in long-term real rates driven by demography).
I think in general economists who are not on TV (economists-who-do-TV is a particular genre, and my professional opinion as an economist who is never asked to do TV is that they tend to be a bit more on the cranks-and-charlatans end of the spectrum) are really not sure how this is all going to play out. The University of Chicago's Booth survey of big-name economists reflects that uncertainty -- a slim majority agreed or strongly-agreed with the statement that the COVID outbreak was likely to cause a 'major recession.' and the nature of that recession -- driven by reduced spending or supply disruptions -- is uncertain.
posted by dismas at 8:14 AM on March 16, 2020 [4 favorites]
Monetary policy works through a number of channels, but essentially what the Fed typically does is affect the interest rate at which banks lend to each other on a short-term ("overnight") basis. They have several tools for doing this -- they have mechanisms that tend to put a ceiling or a floor on those interest rates, and the trading desk at the New York Fed will buy and sell treasury bonds to affect the quantity of bank reserves banks hold (essentially, adjusting the supply of bank reserves in order to keep the price in the range the Fed would like).
Other interest rates tend to follow movements in interbank rates. The Fed lowering rates, through various channels, tends to stimulate investment activity -- when it's cheaper to borrow, more people are willing an able to do it. This tends to reverberate throughout the economy -- the people hired to build new houses might spend more, etc, etc. Broadly, we could label this "aggregate demand management" -- trying to affect the final demand for goods and services, holding fixed the ability of the economy to supply those goods.
Many recessions are characterized by a shortfall in aggregate demand. What's occurring right now has some flavors of that -- people can't work so they can't spend as much, or they're nervous so they don't go out to eat, or maybe hold off on buying a new house, etc. If that were the only problem, then what the Fed's doing would probably ease some of that pressure -- at the margin, some folks who wouldn't be interested in buying a car right now might be because auto loan rates are lower. Whether the Fed's dramatic actions would be enough to completely avoid a recession is another story, but it would be pushing against the general shortfall in aggregate demand.
But there's also a supply side shortfall here -- activity is slowing because people can't get to work. The Fed can't really influence that, or affect supply chain disruptions directly -- at the end of the day, they own a very powerful printing press that they are legally permitted to use for particular purposes.
So what are they doing? They're trying to make sure that the disruptions they can't control don't create other problems they'd like to avoid. For example, stocks are falling for all sorts of reasons right now, but one is surely because of the general macroeconomic implications of COVID-19. The Fed can't create a vaccine, but it's trying to make sure that that financial fallout doesn't, say, turn into a general financial panic. Their concern is that, say, banks that would normally be able to weather this will suddenly be in trouble because everyone's unsure about whether the financial system is going to 'work.' So the Fed's moves in the past couple of weeks are essentially about making sure there's enough money floating around the financial system so that its normal functions continue. (E.g., many firms issue short-term debt to issue paychecks, and the Fed wants to make sure that they can find a lender). As long as the Fed credibly promises that it will provide that liquidity -- acting as a lender of last resort, even if you can't borrow from another bank, you can borrow from the Fed -- then the financial system won't be exacerbating any recession that occurs.
Why are economists interpreting this as a "bad sign?" Well, there's a couple of things. One is if they think the Fed has some informational advantage -- they know something markets (or the public) hasn't realized yet about how bad things are going to get economically. So we see the Fed acting dramatically, and say 'wow, what a bad sign, time to cash out and hide in the woods.' Another problem is that, since the last crisis, the Fed's ability to lower interest rates has been limited -- for practical reasons, it's hard to lower the nominal rate it targets below zero. So as of today, the Fed is going to have to go back to the financial crisis playbook in terms of trying to figure out a way of influencing the economy and financial markets, because they can't lower the fed funds rate any further. That may also be making market participants nervous. (To the Fed's credit, they have been thinking about this since the last crisis; there's been lots of discussion among policy economists about the high probability of recurring ZLB events in the future because of a general decline in long-term real rates driven by demography).
I think in general economists who are not on TV (economists-who-do-TV is a particular genre, and my professional opinion as an economist who is never asked to do TV is that they tend to be a bit more on the cranks-and-charlatans end of the spectrum) are really not sure how this is all going to play out. The University of Chicago's Booth survey of big-name economists reflects that uncertainty -- a slim majority agreed or strongly-agreed with the statement that the COVID outbreak was likely to cause a 'major recession.' and the nature of that recession -- driven by reduced spending or supply disruptions -- is uncertain.
posted by dismas at 8:14 AM on March 16, 2020 [4 favorites]
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Also, algorithms have taken over.
Look at:
All the money in the world
The Everything Bubble
Minsky Moment
High Frequency Trading
Dark Pools
Note that:
Corporate debt is higher than it's ever been.
Price / Earning ratio is still higher than it's ever been.
The majority of trades are held for less than a second.
The majority of trades are in the dark pool.
posted by dum spiro spero at 10:59 PM on March 15, 2020 [3 favorites]