Ben Bernanke Sees a Big If on the Path to Recovery

(Bloomberg Opinion) -- The Federal Reserve has stepped in to save the economy again, this time from the coronavirus pandemic. Not only did it cut interest rates to almost zero, but it unleashed a barrage of new programs to prop up financial markets, and bail out investors and businesses that borrowed too much before the U.S. economy shut down to contain the outbreak. There is precedent for this: On a smaller scale, the Fed came to the rescue in the midst of the 2008 financial crisis. Few know more about central bank bailouts than Ben Bernanke, who led the Fed during that time. Bloomberg Opinion columnist Noah Smith interviewed him online last week. Below is a lightly edited transcript of their conversation.

Noah Smith: The Fed has been extremely proactive during the coronavirus crisis -- increasing its balance sheet by more than in the Great Recession, indirectly purchasing corporate debt, lending to small businesses and so on. Is this enough? Was the Fed sufficiently bold this time around, or could it have done even more?

Ben Bernanke: The Fed has certainly been proactive and appropriately so given the economic situation. Basically, it’s done three things: It’s provided sufficient liquidity to assure that key financial markets, including the Treasury, mortgage and repo markets, can function in a reasonably normal way. It’s backstopped critical credit markets, including not only the markets for corporate paper but also the markets in which state and local governments and medium-sized firms borrow. And it’s eased monetary policy by cutting rates nearly to zero and buying longer-term assets. Broadly speaking, these were the right initial steps.  Will the Fed have to do more? Yes, there will be a need for fine-tuning the terms and scope of the credit facilities, to assure that they are getting credit where it is needed. And the Federal Open Market Committee will need to provide more specifics about their plans for monetary policy. But it’s reasonable to make those adjustments over time, as we learn more about the economic outlook and the effectiveness of the policies already put in place.

NS: So, the Fed is doing a lot, and ready to do more. Is there any danger of doing too much? Theoretical models -- as well as common sense -- suggest that pandemics cause both demand and supply shocks at the same time, and that the effect on prices is ambiguous. Could excessive Fed action conceivably cause inflation? Also, the pandemic may cause long-term shifts in consumer demand, meaning that some of the businesses now being sustained by Fed loans might never be viable again. At what point does the Fed let them die, so that they don't become so-called zombies?

BB: Since the Fed has undershot its inflation target for some time now, it probably would not mind seeing a modest uptick in inflation.  Unfortunately, some disinflation is more likely in the next couple of years than inflation. Although there are some factors that will push up costs and thus inflation — broken supply chains, spot shortages, and the costs of making workplaces and transportation safer, for example — these will be overwhelmed by the disinflationary effects of cautious consumer and business spending, a weak global economy and low commodity prices. Of course, if I’m wrong and inflation picks up more than expected, the Fed has the tools to respond to that.

As a society we do face difficult decisions about which businesses and industries will be viable in the long term. Some reallocation of resources will be necessary and public policy should not prevent that from happening, as ultimately dictated by market forces. The Fed is trying to avoid putting its thumb on the scale, for example, by partnering with banks (who will make the actual lending decisions in the Main Street program), by relying on outside credit ratings and by keeping the terms of its loans relatively short, typically four years or so. The Fed’s goal here is to support the functioning of credit markets in general during this highly uncertain period — not to decide which specific borrowers get credit, which is not its expertise or responsibility. Ultimately the market will determine the shape of the post-pandemic economy.

NS: Got it. So let's talk a bit about what happens to the economy over the next five years or so. Your own research famously showed — and plenty of research has confirmed — that financial crises tend to make recessions deeper and longer by causing companies to go bankrupt or preventing them from being able to borrow. Suppose the Fed manages to prevent a financial crisis and limit corporate bankruptcies to companies that aren't viable in the long-term. Do we still see a multiyear recession? Could dampened business and consumer confidence, uncertainty about shifts in demand, supply chain disruption and other forces create a long slump this time?

BB: The most important factor determining the length of this recession is the state of public health. In a best-case scenario, in which some combination of, say, intensive testing and tracing, new treatments and progress on a vaccine brings the risk of serious illness or death for the average person down to a very low level, then an economic recovery could happen relatively quickly. Many people could just go back to their old jobs, or similar ones. That’s the best case. In an intermediate case, in which risks are lower but still significant, a costly and time-consuming restructuring of the economy could be needed to reduce risks to workers and customers and to reallocate resources away from sectors that have been made uneconomic by the pandemic. In that latter case, recovery will take longer, probably a number of years, because people and firms will be cautious about spending in the face of high uncertainty and because it takes time for workers to retrain and new businesses to be started.

NS: That's a fairly optimistic prediction. But even if the pandemic vanishes relatively quickly and the Fed does all it can, it seems possible that Congress will make policy mistakes that contribute to a longer downturn. Do you see any danger of that? What should Congress's top priorities be for the rest of this year?

BB: Congress has done a good job so far but, given the severity of the problem, more will be needed. First priority should be public health -- from personal-protective equipment to medical research, the return to making people feel safer is very high. Second, state and local government budgets need substantial federal help. States and localities are the front line in education, transportation, public safety and health, and it would be very damaging if they were forced into draconian cutbacks. (We made that mistake already during the recovery from the Great Recession.) Finally, households and small businesses are going to need more relief to get through this. A good way to do this would be to tie relief payments to an indicator like the national unemployment rate, assuring that the payments are around as long as needed but also that they are pulled back when the economy gets stronger.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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