Tuesday, March 3, 2020

Corona virus monetary policy

A colleague and I were discussing the question, should the Fed lower interest rates in response to the corona virus?

More generally, suppose a pandemic gets serious and either by choice or by fiat a large swath of the economy is shut down for a few weeks or months. What should the Fed, or other economic policy do about it?

My first instinct was that the Fed should not lower rates. This is a classic supply shock, and there is nothing more demand can do. What’s the point of encouraging more spending if the stores are closed? Even giving people money doesn't do any good if the stores and factories are closed. The first job of a central bank should be to ask “is this a supply shock or a demand shock” and respond to demand shocks, not supply shocks. This is like stoking demand at night or over the weekend.

But supply and demand aren’t so neatly distinguished. Maybe a supply shock creates its own lack of demand. And a pandemic has demand effects too. People hunker up at home and don’t want to go buy a new boat.  One job of the central bank is to spy what the natural real interest rate is, and move the nominal rate accordingly so there is no force unsteadying inflation. Well, if the economy shuts down, people don’t want to spend, since the stores are closed, so by definition they save. (Unless income is shut off). People don’t want to borrow (except to roll over) for the same reason. The marginal product of capital is nothing. So that argues for a pretty sharp fall in interest rates.

But as I think about it, the right answer is that this is the wrong question, and aggregate supply and demand is the wrong framework for thinking about it. What happens if the economy shuts down for a few weeks or months, either by choice or by public-health mandate? Shutting down the economy -- and more importantly turning it back on again --  is not like shutting down and turning on  a light bulb. It's more like shutting down and restarting a nuclear reactor. You need to do it carefully, and make sure the parts survive the shutdown intact.

I can see huge financial problems. The store and factory may shut down, but the clock still ticks. Businesses must still pay debts, with nothing coming in. They likely have to pay wages -- otherwise, what will people do to buy food? People have to make mortgage payments and rent, likely with no income coming in. Left alone, there could be a huge wave of bankruptcies, insolvencies, or just plan inability to pay the bills. A modestly long economic shutdown, left alone, could be a financial catastrophe. When the economy starts up again, if half the businesses have gone bankrupt in the meantime there is a lot less ready to start.

The problem would be mitigated if we could count on the lost GDP coming back. Then we just need loans against the future output. But the GDP won't come back.  The level of GDP should return quickly -- if these financial problems don't wipe out a segment of the economy. But the GDP not made is not made for good. If you make one pair of shoes a day, when you get sick you don't make shoes. When you get better you can make one shoe a day again, but not two to make up for lost time. Some demands may accumulate, there is some ability to run above capacity for a while, but it's not a one for one gain. So the money needed in the interim cannot be borrowed against future incomes, even if banks would lend it.

In free market nirvana, I guess we would all have pandemic insurance to give us a flood of money in this event, and the pandemic insurers would not go bankrupt on this by definition nondiversifiable event. But that hasn't happened.

In second-best free market nirvana, we would each have recognized that at any moment the economy could shut down for a few months, and each of us -- and every firm -- has enough liquid savings to last, say, six months of expenses with no income. Precautionary savings should do the trick. Paradoxically, though many economists diagnose a "savings glut," that glut is not widespread and there are many hand-to-mouth consumers and highly leveraged companies around. In the old days, when crop failure, famine, pestilence, war, and just plain winter were common, the general reaction was to try to keep enough grain around to get through it. That didn't always work and not for everyone.

So back to the Fed. Absent precautionary savings, one might imagine something like a switch turning off financial claims. But we can't just shut down the whole economy -- people need food, heat, electricity, Netflix - most of us are sitting at home healthy, hospitals, and so forth.

In sum, then, I think we need a detailed, pandemic-induced financial crisis plan, that forestalls bankruptcies and insolvencies where possible,  without causing downstream crises among people who were counting on being paid back, and floods the country with money in the right spots, as insurance would do, but not too many of the wrong spots. Yes, you heard it here, judiciously targeted bailouts are really the only way I can think of to keep businesses and people from going bankrupt given the absence of pandemic insurance.

We need a detailed pandemic response financial plan, sort of like an earthquake, flood, fire, or hurricane plan that (I hope!) local governments and FEMA routinely make and practice.

Is there any such thing? Not that I know of, but I would be interested to hear from knowledgeable people if I am simply ignorant of the plan and it's really sitting there under "break glass in emergency" down in a basement of the Treasury or Fed.  Without a pre-plan, can our political system successfully make this one up on the fly, as they made up the bank bailouts of 2008?

Then we have to figure out how to prevent the atrocious moral hazard that such interventions produce. Pandemics are going to be a regular thing. Ex-post bailout reduces further the incentive for ex-ante precautionary saving. Too good a fire department and people store gasoline in the basement.

This starts down the same bailout and regulate road that suffocates our debt-based banking system. I welcome better ideas.

One might say a rate cut can help provide such liquidity. But the level of the overnight rate is a very small issue to a business that needs a loan to keep up with mortgage or rent, payroll, electric bill, debt payments, there is absolutely no money coming in, can't buy supplies if there were, and the bank is refusing (rightly) to make such a loan at any rate. So, yes, this dark view does argue for a sharp rate cut when serious economic disruption hits. But it's a very small salve to the fundamental problem.

So, as I consider the potential chaos of a reasonably long economic shutdown, monetary policy is about 10th order and the level of overnight rates about 100th order. A detailed financial disaster plan is about 3nd order. Getting people to stockpile enough liquid assets ahead of time is second order.  Public health plans, also apparently being made up on the fly, are first order. My guess is that our government has even more drastically underinvested in the financial pandemic plan than it has in the public health pandemic plan.

Corona virus may seem small. "Only" 2% of people die from it. If it sweeps the planet unchecked, that's 150 million people, on the order of WWI, WWII, Stalin, Hitler and Mao put together, though less concentrated and somehow, as in 1918, less vivid. And corona virus is our Bear Stearns. We've had SARS, MERS, Ebola, various flus, and now corona virus. Globalization leads to pandemics. Remember 1350 and 1492 as well as 1918.  There will be more. In the next 100 years there could easily be one with  20% mortality that shuts down the economy down for a year.  Can our economic and political system handle that? Are we faintly prepared? People who say climate is the worst problem facing civilization have a remarkable lack of imagination in my view. Maybe we should be spending 1/1000 of the resources that go in to energy policy on pandemic prevention.


Update. Air kill has a great example.  Allow withdrawals from retirement accounts without penalty.  A letter to the Wsj had another.  Put hand sanitizer next to immigration touchscreens. This is why you need a plan. Bureacracies will never think up and implement these thousands of steps in real time

Update 2: This is included in a very quick compilation of essays into a VoxEU instant book, here. 

Update 3: French translation here or direct link


  1. The key is the avoidance of a break-down in the inter-bank clearing systems. Ensuring that this crucial aspect of a modern economy remains functional under the stress of an epidemic or pandemic is the task that central bank is designed to perform.

    The economy is not dependent on one supplier or one supply chain. The scenario you paint is unlikely to materialize. Your speculation of 20% or higher mortality rates is far fetched--you're basically talking about a world war scenario in that case, and we've had some experience with management of an economy under those circumstances. If needs must, then liberties are curtailed and a command economy substitutes for a free market economy, until the crisis passes.

  2. Like you, I see dangers to debt servicing because of supply and demand shocks due to this virus. If people can't work, they can't earn an income, which then finds its way back into the economy through spending. It's hard for businesses to pay down debt unless revenue is coming in.

    Yes, people are consumers and producers at the end of the day. But what the virus has really done is expose underlying weaknesses in the larger economy and the underlying infrastructure, too.

    Lower rates may help a bit, but maybe something along the lines of restructuring debt so it doesn't blow up right now would be useful. Municipalities need resources to respond, too, which is a function of government and spending. Yes, it's kicking the can down the road, but how is that different than what's been going on, hmm?


  3. Fed does not need to lower ff because of covid19. The fed needs to lower rates because of 87 BP two-year and 113 BP ten-year yields.

  4. Fed does not need to ease because of covid19. The fed needs to ease because of 87 BP two-year and 113 BP ten-year yields.

  5. The connection between climate change and infectious diseases has been apparent for a long time. So perhaps, you aren't taking climate change seriously enough:

    "Changes in infectious disease transmission patterns are a likely major consequence of climate change. We need to learn more about the underlying complex causal relationships, and apply this information to the prediction of future impacts, using more complete, better validated, integrated, models."


    1. Aha ask the scientist fraudster what to do and they will tell you more money and bigger computers for them! Suggest drafting everyone of them into an army where they get Squaddie wages and 24 hour details and see how long the fraud lasts?

    2. Ask the scientist fraudsters what to do and they will say give them more money and bigger computers! As it is a global emergency draft them all into the army on squaddie wages and 24 hour call and see how long the emergency lasts?

  6. Maybe instead of a plan that "that forestalls bankruptcies and insolvencies where possible" you want one that speeds those up, perhaps by offering rougher justice than what people might normally expect. These are potentially shocks that should result in significant changes to how resources and labor are used and the more quickly those get made, the better. For example, if people stop eating at restaurants, the proper response might be to wait until demand recovers-- but it seems at least as likely that the proper response might be to reconfigure restaurants so there is less risk of transmission of viruses, or to turn them into theaters for the production of Youtube videos. Even well executed bailouts prevent these sorts of reconfigurations. Nothing is certain, but as usual I think the odds are that a better answer will be found in the markets than in government policy. (For the record, I *don't* make the same argument for pure public heath issues, like vaccination requirements or quarantines.)

  7. Fed has ticked the box and passed the buck to Trump, with a friendly note: "We've done our bit, now would you mind waking up?"

  8. I posit the following
    1. what is an acceptable death rate versus shutting down the economy and the resultant death that will occur with the economic dislocation.
    2. It is comedic to pretend that society has a rainy day fund, perhaps 20% do, another 40% will tap their retirement programs ( will the Gov't forego the 10% penalty)as for the last 40% 10 to 14 days and the lines will begin. Good luck to landlords in the inner city, although I'm willing to posit for middle class MTG holders it will be a rollover of months.
    3. Fear may induce people to buy Gov't paper, but with tax receipts down pressure rises up thru the system, (local state federal) larger deficits reduced services and more pressure on future entitlement programs.
    4. needed items may be inflationary but the larger economy will be deflationary which again will exert more pressure on lower income households.
    5. Seniors who are at greatest virus risk, will benefit in no way from the rate cut, in fact will suffer economically in a disproportionate amount. Insurance Co's. already this morning are reducing rates. Is TINA the alternative to secure a 20 year+ retirement for someone in or near retirement.
    6. the medical system will be exposed, whereas we will not be able to service the needs of the population in basic care, both inner city and rural. The low R.O.I. needs will be exposed, but you'll be able to get the Hep. C. cure no problem.
    7. let us hope! that they have an effective vaccine by fall 2021.
    8. It would be better for the Gov't to allocate funds to needs and services, and get past it's peoples fault for not being better
    prepared. In our current political malaise this will occur and how dangerous that in itself, may become.

  9. As Michael Antonelli quipped on twitter yesterday: In 4 billion years the Milky way is going to crash with Andromeda. Imagine the rate cut we'll need then.

    As for the free-market nirvana, the world bank actually started offering a public/private partnership pandemic bonds last year, albeit in a fairly limited quantity and only aimed at helping poor countries: http://pubdocs.worldbank.org/en/670191509025137260/PEF-Framework.pdf. They function like catastrophe bonds. Notably, coronavirus has yet to trigger payments.

    Mortality, especially of the young and healthy, seems to be overblown. In Stanford dorms, the pandemic is already morphing into a bit of a meme. But if the economy does shut down for a quarter, or more, what happens to tax receipts this year? Government revenue drops $500 billion, just as the need for large expenditure skyrockets...

  10. I am still unclear what the Fed's expected mechanism is supposed to be here. Lowering the rate of interest on reserves in theory should incentivize the banks to lend more of their excess reserves. But is such a small spread difference really the margin between a bank deciding to lend or not?

    I've heard other theories that this sends a market signal for consumers and investors passively sitting on their own cash reserves to put the money "out there".

    Does anyone have a theory about what credible mechanism exists for the rate cut offsetting lower demand?

    1. Yes. The FEDs cut is NOTHING to do with the bank lending. It is about improving the ability of firms and households to service debt, so it reduces the burden of adjustment on employment and spending. This acts to prevent demand falling as much. Higher asset prices also improve borrowing constraints. I'd recommend reading up about channels of monetary policy - this is the interest rate channel in action.

  11. Where is the innovative free market entrepreneur who could produce small hazmat scrubs for public consumption. The uses would be myriad. A full protective suit that allowed one to comport in public might cost fifty bucks.

  12. Stanley Fischer recently advocated helicopter drops through a standing facility operated by the Federal Reserve.

    I do not think conventional monetary policy can respond to a sudden supply and demand shock. The Federal Reserve can engage in quantitative easing, but that amounts to buying bonds on globalized capital markets, and money is a fungible commodity. Ergo, buying bonds will not do much for the economy within the geographic area of the United States. In fact, quantitative easing might be described as a helicopter drop for Wall Street, but what is needed is it helicopter drop on Main Street. And interest rates are already low.

    I think Stanley Fischer idea is the right one.

    For those of you with a sense of humor and who want to learn about helicopter drops and coronavirus, see this:


    By the way, I think the actual death rate from coronavirus is probably less than half a percent. South Korea, which does everything well, is testing widely and has the lowest death rate. But even in South Korea they cannot test everyone who has been exposed to coronavirus but is asymptomatic or had only mild symptoms.

  13. I am hardpressed to see how lowering interest rates will do anything beyond comforting people that "our government is on top of things." Shutting down segments of the economy due to the coronavirus looks a lot like shutting down segments because of blizzards, ice storms, tornadoes, earthquakes, floods, etc. It may last longer but other than that it is pretty much the same. As such, cutting rates won't do anything positive and may cause problems later on. As was pointed out it is the loss of income while the meter still turns on debt obligations that is the problem. Developing a plan for forbearance may be more useful.

  14. The entire premise of this article is stupid.

    Creditors are not puppets waiting for directions and neither are debtors. Given that a one time shock like covid-19 says very little about long-term credit-worthiness, both have an incentive to negotiate a settlement that avoids bankruptcy costs.

    The incentives are aligned so leave things alone.

  15. Too bad they can't print antibodies.

  16. Quoted: "Getting people to stockpile enough liquid assets ahead of time is second order."
    But in a really severe supply shock, liquid assets in the form of cash or debit card might not really buy you anything much. Maybe the Mormons have the right idea: canned goods and dried food.
    I think I would want to go buy myself a supermarket, which I manage. In a pandemic, I could "close" and invite my friends to bring their shotguns to enjoy defending the "liquid asset." A good auxiliary generator would be needed too, since electronics will cease.

  17. In Italy, the government has suspended regular tax payments in the most affected areas (I think it means postponed), and mortgage payments (my understanding is that the banks bear the cost). This is a version of what you're thinking I think.

  18. Shameless self promotion: Check out "Like a Good Neighbor: Monetary Policy, Financial Stability, and the Distribution of Risk" IJCB, June 2013, for an analysis of the appropriate monetary policy response to supply shocks that addresses your concerns about the implications of such shocks for debtors and others with fixed nominal obligations.

  19. "Shutting down a nuclear reactor. You need to do it slowly and carefully or it melts down."

    Not really true about nuclear reactors. Chernobyl was unusual in that it could not be safely half shut it down and then rapidly shut down, to oversimplify. Radiochemistry is complicated! All that was understood by the designers; it was bad design in that the fact was too subtle to be remembered by the operators.

  20. There's nothing to worry about corona virus, as this is an imaginary disease formulated by the perpetrators in exchange of greed for power, huge money, and depopulation, according to Dr. Lorraine Jeanette Day, a US author, former orthopedic trauma surgeon and Chief of Orthopedic Surgery at San Francisco General Hospital and promoter of alternative cancer treatments. Formerly, she's also an adviser at Center for Disease Control & Prevention (CDC)

    I'm sharing this to help people to lessen fears.

    According to the Doctor, viruses and bacteria do not cause a disease but these serve as a clean-up crew which regulates intakes/abuses of the human body. She said that all doctors are aware of this as this is published in medical literature.

    You may check this video which I uploaded in my youtube account, for more details.


  21. Hi John, I posted this under your other virus post but I think it's better here. I think you are right to identify the crux of the financial problem as "the clock still ticks". It needn't.

    - We know how to eradicate the virus - if everyone in the world stayed home in isolation for a month, the virus would die out.

    - Why don't we do this? Because of the economic and financial disruption it would cause. Primarily with scheduled cash flows - wages, rents, coupons, any payments relating to any financial contract whatsoever, where failure to be met could set of a cascade of defaults, bankruptcies etc. (Other less critical problems are created with respect to anything that relies on prescheduled calendar commitments - meetings, weddings, sporting fixtures etc)

    - When we do ask significant numbers of people to self isolate, any mitigation we attempt with respect to the financial/economic problems is either piecemeal and reactive (e.g airline bailouts, emergency credit facilities) or blunt and badly targeted (tax cuts, rate cuts etc)

    - What should we do? At a global level (UN, G20) we should agree to insert a one-off 30 day period into the Gregorian calendar, say the day after 31 Mar. Let's call it Coronovember.

    -During Coronovember, the population is under self-isolation quarantine, enforceable by law.

    - During Coronovember, governments agree to provide 3 services: waste disposal, emergency medical, and food supply. That is your targeted fiscal spend

    - When the 30-day period is over, the Gregorian calendar starts again on 1Apr, and every prescheduled payment/contract/event happens on exactly the day it was supposed to

    - We can literally pause time to let the virus die out. Unfortunately people still need to eat, shit, and have medical emergencies, which is where the governments need to be the stop gap

    The only major pushback I have had is that "the seasons will be out of whack by a month". Which, like, really? if we really care about the fact that September is a bit colder than it used to be, we can amortize it back over 30 years or something. Take a day off October - who needs Halloween anyway?


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