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As stock markets tumble because of coronavirus, this time feels different

Feb 28. 2020
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By The Washington Post · David J. Lynch 

The coronavirus panic that sent stock markets tumbling this week has triggered calls for the federal government to intervene, relying on traditional playbooks that the Federal Reserve, Congress and the White House have used in numerous previous crises.

This time, though, the usual approach might not work.

Typically, the Fed responds to economic trouble by lowering interest rates to make credit easier to obtain. It also can offer loans to banks via the "discount window" or buy large quantities of U.S. Treasury securities to offset any general tightening in financial conditions. Congress, meanwhile, can approve new spending or tax cuts to flood the economy with money.

But the best remedy for the coronavirus - which has sickened more than 83,000 people worldwide and killed nearly 3,000 - could lie beyond Washington's immediate powers.

"Central banks don't make vaccines," said David Kotok, chairman of Cumberland Advisors.

The stock market plunged again on Friday, with the Dow Jones Industrial Average sinking an additional 1,000 points or nearly 4% on top of its week-long decline.

The renewed selling intensified calls for the Fed to rescue the economy from an unforeseen shock. The medical emergency already has disrupted global production networks, curtailed air travel and hobbled economies in Asia, Europe and the Middle East. With medical experts urging Americans to prepare for serious disruptions in their daily lives, pleas for early action are coming from Wall Street and some former members of the Fed's rate-setting committee.

"The Fed can't fix broken supply chains or calm concerns about health and safety. But the Fed can ensure that liquidity conditions remain supportive, so firms can get funding through the disruption. It can also provide support to financial markets," said Nathan Sheets, chief economist for PGIM Fixed Income. "More generally, the message that the Fed is attentive and 'on the case' has tended to help soothe the economy and the markets during past episodes."

On Friday, investors were pricing in a 100% likelihood that the Fed will cut rates by at least a quarter percentage point at its March 18 meeting. That represented a sharp and sudden change from one week ago, when just 11% expected Fed action, according to the CME Group.

But this time, the Fed's classic crisis-fighting tools may not be as effective. Economists call episodes like the epidemic or the Sept. 11, 2001, terrorist attacks an "exogenous shock," meaning an unpredictable development that arises from outside the economy or financial system yet has significant economic consequences.

The Fed normally acts only after assessing voluminous data on business and consumer activity, using sophisticated computer models that forecast the future by comparing current conditions to what's happened in the past.

Recessions typically occur after the Fed has begun raising interest rates to head off incipient inflation or after warning signs such as widespread layoffs or falling equipment orders. Likewise, as the economy gradually deteriorates, officials in the White House or on Capitol Hill can make plans to ramp up government spending or to cut taxes.

The coronavirus, which first emerged in China and has now spread to countries including South Korea, Japan, Italy, Iran, Brazil and the United States, poses a unique challenge. In this case, the virus emerged with no warning and, after initially appearing to be confined to China, swept multiple countries - with perhaps more to follow.

President Trump, who has been criticized for a delayed and uncertain response to the crisis, so far has given no hint of plans for any economic stimulus.

China stands as a cautionary tale. The Chinese government's aggressive measures to fight the crisis, which included imposing quarantines over an area that is home to perhaps 60 million people, chilled both supply and demand.

China's virus-fighting campaign prevented employees from leaving their homes and working on assembly lines, thus depressing the supply of goods. And it kept people from patronizing restaurants, movies or retail stores, thereby cutting demand.

If the United States suffers a serious outbreak and people stay home fearing possible contagion, cutting interest rates would probably do little to convince them to return to work or go out to shop or dine. "This is a very tough one for the Fed to deal with," said Dean Baker, senior economist at the Center for Economic and Policy Research.

The Fed has a long history of fighting financial and economic downturns, including the 1987 stock market plunge known as Black Monday and the Russian debt default more than a decade later. In 2008, following the collapse of the housing bubble, the Fed dropped interest rates to zero and held them there for years in a bid to resuscitate the U.S. economy.

The Fed moved quickly in the wake of 9/11 to make sure that the casualties did not include the U.S. economy.

Six days later, with financial markets closed and smoke still curling from the World Trade Center rubble, then-Fed chairman Alan Greenspan cut the benchmark U.S. lending rate by half a percentage point. The central bank also pumped $102 billion into the financial system to grease the gears of the economy and ease an anticipated slowdown, according to a subsequent study by the Federal Reserve Bank of St. Louis.

In the case of the coronavirus, Fed officials have been cautious thus far in their public comments. Richard Clarida, the Fed's vice chairman, said earlier this week that the upheaval in China could reverberate through the global economy. "But it is still too soon to even speculate about either the size or the persistence of these effects, or whether they will lead to a material change in the outlook," he said in a speech to an economists conference in Washington.

For the past three years, the Fed has helped investors shrug off Trump's serial trade wars; his verbal attacks on companies such as Harley-Davidson, Boeing and Amazon; and even his impeachment by House Democrats. (Jeff Bezos, Amazon's owner, owns The Washington Post.) The Fed cut interest rates three times last year and was expected to stand pat this year.

Between Election Day in 2016 and Feb. 12 of this year, the Dow Jones industrial average rose by 61%. In four days this week, it surrendered one-third of that gain as investors puzzled over what the virus will mean for corporate earnings.

By itself, this week's historic stock market meltdown - erasing nearly two years' worth of gains and incurring the fastest 10-plus-percent drop in history - highlights the current peril.

Economists are struggling to assess the extent of the calamity amid conflicting information about the virulence of the illness, the likely public reaction if it spreads in the United States, and the potential response from the Fed or the Trump administration. To some, the profound uncertainty recalls the financial crash that hit the United States and Europe more than a decade ago.

"Forecasting in this environment feels eerily reminiscent of the crises - the ground keeps shifting beneath me as I try to gain my footing," Diane Swonk, chief economist at Grant Thornton, tweeted on Thursday.

The cloudy outlook shows no signs of clearing any time soon. On Friday, Fitch Solutions, a country risk analysis firm, said it was revising down its forecasts for several European economies, including Germany, after already having lowered its Asian estimates.

One day earlier, Fitch said South Korea would grow by just 1.7% growth this year, down from its 2.2% original forecast. And that estimate could go lower, the firm said, citing the risk that "the outbreak will not be controlled by June."

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