• Bull.




This commentary was written yesterday by Dr. Daniel Thornton of D.L. Thornton Economics. Thornton spent over three decades at the St. Louis Fed as vice president and economic advisor.

Thornton: Monetary Policy Reaches New Low - 02.21.2020 Fed mask cartoon

The Federal Open Market Committee’s (FOMC’s) decision today to reduce its target for the overnight federal funds rate by half of a percentage point is either an act of economic and monetary policy foolishness, or it caved in to pressures from President Trump, who suggested the Fed should take the lead by cutting interest rates.

These are not mutually exclusive. It could be both.

I consider today’s action to be one of the silliest things the FOMC has done since the October 28-29, 2008, FOMC meeting. The FOMC voted unanimously to cut the funds rate target from 1.5% to 1.0% in spite of the fact that the funds rate averaged just 82 basis points during the prior two weeks and had dropped to 67 basis points the day before Bernanke proposed the rate cut. Bernanke justified his recommendation saying, “it will be at least moderately beneficial both in terms of psychology and in terms of reducing the cost of funding and giving some additional support to funding markets.”[1]

Of course, he never said exactly why it would have beneficial psychological effects. Nor did he say how it would reduce funding costs.

The FOMC should have proclaimed its independence by saying reducing the funds rate now would be ineffective in combating an economic downturn created by concerns of a global pandemic. It should have explained that output is falling because businesses are shutting down and people are staying home because they are afraid of contracting a virus that gives them a 2% or so chance of being dead in a couple weeks.

In China and elsewhere entire cities are shut down—nothing is going on. This strain of the corona virus appears to be especially insidious.

For some, the symptoms are so mild they don’t even know they have it, but they can pass it along to others. Things are likely to get much worse before they get better. More businesses are likely to shut down, more people will stay home from work and more cities may shut down. In this environment, the outlook for the economy is determined by expectations of the path the virus will take.

A 50 basis point, or even larger, rate cut will not change expectations for the virus’ path. It will not get consumers to spend more or businesses to make investments or firms to reopen their plants or workers to return to work or countries to reopen cities.

In any event, the FOMC is, once again, late (see my last essay here). The 10-year and 2-year Treasury rates had already declined about 50 basis points by February 28. Long-term rates, which the FOMC has little influence over, tend to be procyclical; they increase during economic expansions and decrease during economic downturns. When things are looking particularly good or bad, shorter-term rates follow their lead.

While FOMC rate cuts in such an environment can do nothing to offset the effects of the virus, it can increase uncertainty. The reaction of the stock market suggests market participants took the FOMC’s announcement as a signal they should be more concerned about the economic outlook.

Not “The Fed is here to save the day”!

[1] Transcript of the October 28-29, 2008, FOMC meeting, p. 154.



This is a Hedgeye Guest Contributor piece written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.