11 Mar 2020 4 min read

The cavalry are coming

By Tim Drayson

As the US begins to quantify the scale of the coronavirus and the potential economic damage, a significant policy response is gathering momentum.


One economic concern about the spread of the coronavirus is that it creates a feedback loop that will exacerbate the negative impact on growth: containment efforts will lower both supply and demand for many goods and services, and reduced demand will lower supply further, and vice versa.

But it is important to remember that another feedback loop is likely to be especially strong in this crisis: the greater the disruption in the economy and financial markets, the greater the scale of the probable US policy response.

If the situation deteriorates, there are several reasons to believe that US policymakers could act swiftly and aggressively:

• The degree of perceived ‘moral hazard’ of providing fiscal stimulus is lower when the danger is seen as being beyond the control of business and individuals. Stimulus packages cannot incentivise future natural disasters in the way that bailouts can encourage irresponsibility.

• Inflation is below target and inflation expectations are even lower. There is no constraint on the Federal Reserve’s (Fed’s) willingness to reflate the economy, just questions around its ability to do so.

• The collapse in interest rates eases fiscal constraints on the federal government.

• The financial crisis taught policymakers to react quickly to prevent longer-lasting damage from defaults and unemployment.

• The administration is desperate to prop up the economy and markets, as success on these fronts is critical to President Trump’s chances of being re-elected.

While economic policy can’t cure the virus, we see three channels through which US officials can mitigate the disruption to the economy during the current crisis and help promote a rapid normalisation once the virus fades.

US monetary policy

If the Fed decides to act, what could it do? We list six main options:

• Use liquidity facilities as aggressively as needed (it has already increased repo operations).

• Cut rates to zero (perhaps at the 18 March meeting, or even earlier if markets experience further major drawdowns).

• Issue forward guidance committing to stimulus measures, at least until inflation recovers.

• Deploy asset purchases (the most effective at this stage would be of mortgage-backed securities, which would reduce their spread over Treasuries to make mortgage refinancing even more attractive for homeowners, but the Fed could also target yields to prevent them rising too abruptly, if necessary).

• Ask Congress for new legislation to broaden the scope of its asset purchases to include equities or private credit, although the Fed will be reluctant to do this and it would probably require sustained market dislocation first.

• Set up lending facilities to nonfinancial borrowers for liquidity purposes under Section 13(3) of the Federal Reserve Act; restrictions from the Dodd-Frank Act could perversely make this more generous than in 2008-09, as it now has to be open to a broad group of counterparties and not just individual firms.

US fiscal policy

This week, Trump has promised “very dramatic” measures, with early speculation focused on a potential payroll tax cut. However, this requires Congressional approval: Democrats will not wish to help Trump’s chances of re-election, but equally don’t want to be blamed for making any crisis worse. There would also be a large fiscal cost from a payroll tax cut, which would not be particularly helpful during the period of disruption.

Other fiscal options include:

• Federal funding to help directly with increased healthcare costs from the coronavirus and research to find treatments and vaccines.

• Expansion of paid sick leave for those self-isolating.

• Direct fiscal support to the most affected industries, perhaps in the form of subsidies or a delay to or reduction in tax payments to help with cash flow (although this could prioritise the shale industry, which is facing a different challenge after Saudi Arabia’s recent actions sent the oil price plummeting).

We would expect the White House to test the limits of executive orders in providing fiscal support, although it should be remembered that there would be lags involved with any federal spending increases. This would render them fairly ineffective if the virus’s impact proves temporary but, if there is some permanent demand destruction, infrastructure and other spending could help reduce unemployment and return the economy back to its potential.

Regulatory forbearance

US regulators have now instructed the country’s banks to show more lenience with their customers and have promised to reduce criticism of action taken to support business. Moreover, US banks are comfortably passing their stress tests; these could be relaxed further and capital requirements could be streamlined.

Tim Drayson

Head of Economics

Tim keeps a close watch on global economic developments, with a particular focus on the US. He believes nothing good ever happens after midnight, which is why he is rarely spotted out late. Tim joined in 2008 from the number-one ranked economics team at ABN AMRO, with prior experience from HM Treasury, and graduated with a MSc from the University of Nottingham. When not crunching economic data, he can be found studying the weather forecast, analysing his cycling statistics or looking anxious on three-foot putts.

Tim Drayson