Why Fed Officials Are Begging for More Stimulus From Lawmakers

By Nick Timiraos

Federal Reserve officials don't like to wade into political debates, which is why it can be a distress signal when they do.

In normal times, central bankers generally avoid making specific recommendations on hot-button spending, tax and other policy matters handled by elected officials, because they want to preserve their autonomy to manage monetary policy with minimal interference.

These aren't ordinary times. Fed Chairman Jerome Powell has delicately but resolutely said in recent months he expects Congress will need to do more to compensate for income losses sustained by unemployed workers and revenue holes facing hard-hit businesses and city and state governments because of the coronavirus pandemic.

Some colleagues have been more outspoken. "Trouble is brewing with the expiration of these relief policies," Chicago Fed President Charles Evans told reporters in early August after temporary federal unemployment benefits lapsed.

A month later, after little congressional progress on a new financial assistance package, Mr. Evans cited partisan politics as a threat to the economy. "A lack of action or an inadequate one presents a very significant downside risk to the economy today," he said.

The economy has rebounded this summer, but some easy gains were expected. The ranks of temporarily laid-off workers have fallen by two-thirds, or around 12 million, since the spring. Officials are uneasy because more than two million Americans have permanently lost their jobs, and these numbers seem likely to increase as vulnerable businesses shut down.

"We do think it will get harder from here," said Mr. Powell in an interview with National Public Radio earlier this month.

Fed officials are eager for a fiscal booster shot for two reasons. The first reflects the limits of their tools that became apparent well before the pandemic-induced downturn. The second stems from the unique nature of the current shock.

Officials will wrestle at their two-day meeting that concludes Wednesday with how to put meat on the bones of their new average inflation framework. The changes were a response to a deficiency in their old framework, which failed to account for more frequent and extended episodes at the so-called lower bound, where interest rates can't be lowered once falling to near zero.

If the central bank targets 2% inflation and consistently falls short once rates are pinned that low, expectations of future inflation can slide, causing inflation and rates to stay low. The new policy tries to break this vicious cycle by seeking somewhat higher periods of inflation after periods of below-target inflation.

With the Fed unwilling to cut rates below zero, officials are focusing on how to provide more stimulus through "forward guidance" specifying how long they plan to keep rates very low and continue buying Treasury securities and mortgage bonds. They could do this by spelling out inflation and labor-market conditions that would warrant tighter monetary policy.

Forward guidance and asset purchases helped lower long-term rates, which can boost investment and spending, after the 2008 crisis. But they may provide less zip today, because long-term yields are much lower -- a reflection of how investors already expect a longer period of low rates.

Around half of economists surveyed this month by The Wall Street Journal don't see the Fed raising rates before 2024. Futures markets show investors expect the first Fed rate increase in the second half of that year.

As a result, "the Fed cannot assume that forward guidance is going to do very much," said Andrew Levin, a former Fed adviser who co-wrote a paper last month on the limitations of such policies during the pandemic.

Even if the Fed had the ability to make deeper rate cuts, increased government spending would be more effective than monetary stimulus, according to new research from Michael Woodford, a Columbia University economist who is influential in central banking circles.

Textbooks say when a downturn hits, central banks can stabilize the economy by lowering interest rates to offset declines in spending and demand. But Mr. Woodford says this stabilization tool isn't as effective in boosting spending when certain sectors of the economy aren't able to operate for noneconomic reasons.

The coronavirus pandemic "provides a particularly clear example of this kind of case," he said during a presentation at last month's virtual Fed symposium.

Think of the economy as a network of payments. A plunge in income concentrated in a few sectors -- for concerts, hotel rooms or restaurant dining -- can spill over to others for reasons unrelated to the public-health threat. If business owners can't pay rent, landlords have less money to maintain their staffs and cities face a bigger erosion of their tax base, prompting more layoffs.

"These later steps in this chain of effects are all suspensions of economic transactions that are in no way required by the need to stop supplying in-restaurant meals and theater performances," said Mr. Woodford in his paper. Government spending, even if poorly targeted, responds more directly to stopping the disruption of such flows of payments.

This leaves the Fed in a tricky position, one where parts of the economy such as housing and technology that have been less affected by the pandemic might be overstimulated while other sectors languish no matter how low interest rates go.

"We've got a challenge in the sense that the recovery right now is happening in such an uneven way. If you go to Home Depot or a grocery store, things are flying off the shelves in those places," said Atlanta Fed President Raphael Bostic. "But if you think about the arts, or hotels, or restaurants, they are struggling," he said.

Many Fed officials have said they would prefer to know more about how the economic recovery is unfolding before making decisions about how or whether to ramp up more stimulus.

But some analysts say the central bank should follow through promptly on its framework face-lift by delivering more specific guidance. New projections that officials will release this week are likely to show they expect the economy to run below their employment and inflation goals for several years.

"Maintaining a policy status quo in this context would be akin to throwing in a towel, which would undermine the credibility of the new framework right out of the gate," said Aneta Markowska, chief economist at Jefferies LLC.

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