FED Chair Powell addressed media on the state of the US economy yesterday. The FED’s core mandate is to enable maximum employment and maintain the stability of prices within the American economy. The FED data suggests that manufacturing fell drastically in March and fell more this month. Economic activity fell drastically and dropped to an unprecedented rate in Q2. The consumer sentiment (consumption) business investment has drastically declined and is expected to worsen in Q2. All these are components of GDP. The GDP (Gross Domestic Product) is the sum of consumer spending, government purchases, Investment, and Net Exports. Real GDP removes the effects of price increases from the nominal GDP within an economy. Let GDP (Y) be the output of an economy. In Q1, the US economy contracted by 4.8 percent, with unemployment at over 26 million.
Chart: US Bureau of Economic Analysis
The depth & duration of the economic downturn is extraordinarily uncertain in the medium term. And will depend on first, virus containment and second, on the policy actions at all levels in the US government post the healthcare crisis. To support the flow of credit within the economy to smoothen market functioning and policy transformation at all levels, the FED will continue buying assets as needed. The asset purchases include treasuries and agency mortgage-backed securities, and these purchases have slowed down recently. Chair Powell credits these steps as critical in bringing economic stability during the pandemic. The FED is limited in lending to businesses of stable credit ratings to recover the so-called bridge loans that work as a stop-gap arrangement for funding working capital requirements during the crisis. The role of monetary policy is limited and needs to be complemented by fiscal policy to address the needs of the underserved and less privileged community in society. The use of budgetary stimulus (CARES act) for mitigating economic crisis was first expounded by Keynesian economics during the 1929 depression. Over the century has proved remarkably sound in correcting market failures during an emergency. Learn more about in the upcoming macroeconomic tutorials. On the other hand, the FED will serve as a backstop for households, businesses, state, and local government and utilize the power vested in it by the Treasury and Congress to the fullest extent.
The inflation rate will be subdued with low demand and energy prices. The medium-term risks arise from two significant risks:
- The uncertainty about the effectiveness of treatment for the novel virus example, vaccines, other therapeutic cures, etc.
- The risk is more profound. A long-term recession, i.e., depression, can make workers lose touch with the labor force in terms of skills if unemployed for a long time.
- Small and medium rapid solvency will hurt since the value of small and medium enterprises is much more than the intrinsic value in their assets.
Although policy measures can address some concerns, it is not a panacea for the sector. Finally, a prolonged global economic downturn will be immensely detrimental for economies. This aspect brings in behavioral elements apart from the quantitative effects of the recession. The silver lining in the briefing is the rapidity of the economic recovery post the pandemic. However, the uncertainty of the timeline and the colossal social disruption remove any apprehension for a better future.