Central bankers can’t cure coronavirus. But they have the drug markets desperately want, and—at least in the U.S.—they are willing to administer it. Stocks initially jumped after the Federal Reserve’s emergency intermeeting rate cut on Tuesday, the first since the financial crisis. The question is, what use is yet more cheap money for an economy suffering from broken supply chains and from consumers and businesses hunkering down?
The Fed showed once again that central banks can anesthetize investors against bad news, one way to prevent a nasty feedback loop from crashing stock prices into the real economy. But monetary medicine is both unreliable and unpopular, and many of the troubles the world faces can’t be cured by it.
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The European Central Bank, Bank of England and Bank of Japan have all said they stand ready to provide support, but only the U.S. and Australia among developed nations moved swiftly to cut rates.
Markets didn’t much care about the details. The prospect of cheap money was enough to lift the S&P 500 4.6% on Monday and briefly jump on Tuesday.
Monetary policy can help, but there are also core problems it can’t resolve.
On the plus side, monetary policy can smooth over demand problems. The knock-on effect of the coronavirus disruption is that people lose their jobs and companies cut back or, for the weakest in the worst-hit sectors, go bust. Cheaper money allows more companies to survive the bad times and keep paying employees.
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Central banks can support consumer sentiment and make it easier for people to keep spending, too, even if they shift what they buy. One way a recession can happen is that households worried about jobs economize, in turn hitting businesses that otherwise wouldn’t be affected by Covid-19. Lower mortgage payments make households feel richer, and so less worried, while easier financial conditions help banks keep lending.
Finally, monetary policy can keep market turmoil from being a contributor to a recession. When stocks collapse or corporate-bond yields rise, it makes households feel poorer, something known as the wealth effect. It also affects companies: A CEO is less likely to authorize a new project when her share price is tumbling, and a CFO facing a chaotic debt market won’t want to borrow.
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Already debt issues have been canceled and investment plans of some of the most-affected companies put on hold. Cheap money won’t make tourism-related investments any more attractive, but at least it can keep the market functioning and avoid a cash crunch that would in turn feed back into the real economy.
Areas where central banks clearly can’t help: Many supply chains reliant on China and South Korea are broken. Factories that run short of parts or distributors with nothing to distribute can’t operate, no matter how much cheap money is sloshing around.
Changing consumer and management behavior hits many businesses. Government efforts to slow the spread of the outbreak exacerbate supply-chain problems and further change behavior, as big events are banned in some countries, schools closed or cities locked down.
Airlines have fewer passengers even on routes between cities so far little affected, such as London and New York; conferences and public events are being curtailed; and many people have become more reluctant to socialize. Anyone avoiding a flight or a cruise because of virus fears isn’t likely to be tempted back because they can get a cheaper loan.
Then there is the issue of central banks starting with a nearly empty medicine chest, having doled out all the good stuff in rate cuts already. Among the big central banks, the Fed has the highest interest rates at just 1% to 1.25% after Tuesday’s cut of half a percentage point, so none of them can reduce rates by anything like the 5 percentage points or so needed in past recessions.
Who can save the day then? Government support can be better directed at the companies and individuals who need the money, rather than monetary policy’s scattergun approach. The trouble is that governments usually do too little, too late, hindered by politics and the need to design systems that the populace accepts as fair.
The uncertainties remain huge, and anyone investing for more than a few days should be cautious.
Write to James Mackintosh at James.Mackintosh@wsj.com
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