The Fed Needs to Cut Rates Now

Coronavirus poses a risk to global growth, and a reduction would be a cheap insurance policy.

Narayana Kocherlakota

25 Feb 2020, 10:00 AM IST

Jerome Powell, chairman of the U.S. Federal Reserve, speaks during a Senate Banking Committee hearing in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

(Bloomberg Opinion) -- The world economy is facing a material risk in the form of COVID-19, or coronavirus. Of course, it isn't clear how much economic damage the virus will do. But it is clear from the damage being done to China's economy -- and the response of other countries to what’s happening in China -- that the virus could result in a significant worldwide economic slowdown.

Such a global economic slowdown would likely lead to continued upward pressure on the U.S. dollar, which would drive inflation even further below the Federal Reserve’s 2% target in the next couple of years. And a broad slowdown in the world economy would lead to lower U.S. employment growth, as American businesses endure reduced demand for their goods and services.

My benchmark forecast is that the U.S. economy will remain resilient to these forces. But there is a substantial risk that such a forecast could be wrong. One possible strategy is to wait until there actually is a slide in the economy before easing interest rates. But rates are still only a little above zero and so the Fed has few tools available to offset adverse shocks. In this situation, a basic precept of monetary policy is to keep the economy as healthy as possible in advance of downturns. As New York Federal Reserve Bank President John Williams explained in a speech last year, that means cutting interest rates in a pre-emptive fashion when threats to growth become more pronounced. Of course, it was exactly in response to the increase in global downside risks that the Fed cut interest rates by 75 basis points, or three-quarters of a percentage point, in 2019.

The Fed's rate-setting Federal Open Market Committee holds its next meeting on March 17-18. I don’t think that the FOMC should wait that long to deal with this clear and pressing danger. I would urge an immediate cut of at least 25 basis points and arguably 50 basis points. That’s a cheap insurance policy for the economy that the Fed shouldn’t pass up.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net

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

Narayana Kocherlakota is a Bloomberg Opinion columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.