For release on delivery
2:00 p.m. EDT
July 14, 2020
Navigating Monetary Policy through the Fog of COVID
Remarks by
Lael Brainard
Member
Board of Governors of the Federal Reserve System
at the
Perspectives on the Pandemic Webinar Series, hosted by
the National Association for Business Economics
Washington, D.C.
(via webcast)
July 14, 2020
The COVID-19 contraction is unprecedented in modern times for its severity and
speed. Following the deepest plunge since the Great Depression, employment and
activity rebounded faster and more sharply than anticipated. But the recent resurgence in
COVID cases is a sober reminder that the pandemic remains the key driver of the
economy's course. A thick fog of uncertainty still surrounds us, and downside risks
predominate. The recovery is likely to face headwinds even if the downside risks do not
materialize, and a second wave would magnify that challenge. Fiscal support will remain
vital. Looking ahead, it likely will be appropriate to shift the focus of monetary policy
from stabilization to accommodation by supporting a full recovery in employment and a
sustained return of inflation to its 2 percent objective.1
A variety of data suggest the economy bottomed out in April and rebounded in
May and June. Payroll employment rebounded strongly in May and June. Retail sales
jumped 18 percent in May, exceeding market expectations, and real personal
consumption expenditures (PCE) are estimated to have increased 8 percent. Consumer
sentiment improved in May and June.2 And both the manufacturing and
nonmanufacturing Institute for Supply Management indexes jumped into expansionary
territory last month. Financing conditions remain broadly accommodative on balance:
They continued to ease over recent weeks for nonfinancial corporations and
municipalities, although they remained stable or tightened slightly for small businesses
and households.3
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The earlier-than-anticipated resumption in activity has been accompanied by a
sharp increase in the virus spread in many areas. Uncertainty will remain elevated as
long as the pandemic hangs over the economy. Even if the virus spread flattens, the
recovery is likely to face headwinds from diminished activity and costly adjustments in
some sectors, along with impaired incomes among many consumers and businesses. On
top of that, rolling flare-ups or a broad second wave of the virus may lead to widespread
social distancing-whether mandatory or voluntary-which could weigh on the pace of
the recovery and could even presage a second dip in activity. A broad second wave could
re-ignite financial market volatility and market disruptions at a time of greater
vulnerability. Nonbank financial institutions could again come under pressure, as they
did in March, and some banks might pull back on lending if they face rising losses or
weaker capital positions.
A closer look at the labor market data hints at the complexity. The improvement
in the labor market started earlier, and has been stronger, than had been anticipated. Over
May and June, payroll employment increased by 7.5 million, the unemployment rate fell
3.6 percentage points, and the labor force participation rate rose 1.3 percentage points.4
The large bounceback is a sharp contrast to the Global Financial Crisis, when the initial
employment decline was shallower and it took much longer before a similar share of the
initial job losses was recouped.
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The job gains in the past two months were concentrated among workers who were
on temporary layoff. They likely were driven by an earlier-than-expected rollback of
COVID-related restrictions as businesses ramped up hiring and consumers exhibited
more comfort engaging in commercial activities, as well as by a boost to employment
from the Paycheck Protection Program. While nearly all industries experienced
increases, the improvement was especially notable in the leisure and hospitality sector,
which had been particularly hard hit by COVID-related closures in April.
It is unclear whether the rapid pace of labor market recovery will be sustained
going forward, and risks are to the downside. The pace of improvement may slow if a
large portion of the easiest gains from the lifting of mandated closures and easing of
capacity constraints has already occurred. Moreover, weekly COVID case counts have
been rising, and some states are ramping up restrictions. These developments mostly
occurred after the reference period for the June employment report. After declining at a
fast clip through early June, initial claims for unemployment insurance have moved
roughly sideways in recent weeks and remained at a still elevated level of 1.3 million in
the week ending July 4.5 Some high-frequency indicators tracked by Federal Reserve
5
The flattening out seen in recent weeks is even clearer when looking at nonseasonally adjusted claims
numbers, which might be a slightly better measure than seasonally adjusted numbers in the current
environment. The usual seasonal adjustment procedure, which relies on multiplicative seasonal factors, is
not ideally suited to the current extraordinary circumstances. See Jason Bram and Fatih Karahan (2020),
"Translating Weekly Jobless Claims into Monthly Net Job Losses," Federal Reserve Bank of New York,
Liberty Street Economics (blog), May 7,
https://libertystreeteconomics.newyorkfed.org/2020/05/translating-weekly-jobless-claims-into-monthlynet-job-losses.html.
In addition, the Department of Labor stated that 49 states reported about 1 million initial claims for
Pandemic Unemployment Assistance (PUA) in the week ending July 4. However, since most PUA
applicants must first apply for, and be denied, regular state unemployment insurance (UI) benefits before
they apply for PUA, initial PUA claims and initial claims for regular UI benefits will be strongly correlated
(likely with some lag) and do not constitute independent measures of the number of unemployed persons
seeking unemployment benefits.
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Board staff (including mobility data and employment in small businesses) suggest that
the strong pace of improvement in May and the first half of June may not be sustained.
The pandemic's harm to lives and livelihoods is falling disproportionately on
black and Hispanic families. After finally seeing welcome progress narrowing the gaps
in labor market outcomes by race and ethnicity in the late stage of the previous recovery,
the COVID shock is inflicting a disproportionate share of job losses on African American
and Hispanic workers. According to the Current Population Survey, the number of
employed persons fell by 14.2 percent from February to June among African Americans
and by 13.4 percent among Hispanics-significantly worse than the 10.4 percent decline
for the population overall.6
Separately, on the other side of our dual mandate, inflation has receded further
below its 2 percent objective-reflecting weaker demand along with lower oil prices in
recent months. Both core and total PCE price inflation measures have weakened, with
the 12-month percent changes through May standing at 1.0 percent and 0.5 percent,
respectively.7 Measures of inflation expectations are mixed; while market-based
measures have moved below their typical ranges of recent years, survey measures have
remained relatively stable within their recent historical ranges.8 Nonetheless, with
6
The Current Population Survey (or household survey) measures the number of employed persons and
includes detailed demographic information, whereas the Current Employment Statistics survey (or
establishment survey) measures the number of jobs in the payrolls of nonfarm establishments.
7
That said, the trimmed mean PCE inflation rate calculated by the Federal Reserve Bank of Dallas over the
12 months ending in May remained stable at 2.0 percent; the data as of May 2020 are available on the
Bank's website at https://www.dallasfed.org/research/pce. And this morning's Consumer Price Index (CPI)
data for June showed some signs of stabilization, with both core and total CPI inflation increasing
noticeably last month, driven by a partial rebound in price categories that seemed most affected by social
distancing in prior months (such as apparel, accommodation, and transportation services).
8
The median 5-to-10-year measure from the University of Michigan Surveys of Consumers and the median
three-year-ahead expected inflation from the Federal Reserve Bank of New York's Survey of Consumer
Expectations both came in at 2.5 percent in June-well within their ranges in recent years. Median
longrun expectations from the Survey of Professional Forecasters ticked down 0.1 percentage point to
1.9 percent in the second quarter, which is historically low for this measure. Market-based measures of
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inflation coming in below its 2 percent objective for many years, the risk that inflation
expectations could drift lower complicates the task of monetary policy.
The strong early rebound in activity is due in no small part to rapid and sizable
fiscal support. Several daily and weekly retail spending indicators tracked by Federal
Reserve Board staff suggest that household spending increased quickly in response to
stimulus payments and expanded unemployment insurance benefits. Household spending
stepped up in mid-April, coinciding with the first disbursement of stimulus payments to
households and a ramp-up in the payout of unemployment benefits, and showed the most
pronounced increases in the states that received more benefits.9 With some of the fiscal
support measures either provided as one-off payments or slated to come to an end in July,
inflation compensation over the next few years have retraced much of their sharp declines in mid-March
but remain below their typical ranges in recent years. The 5-to-10-year measure of longer-term inflation
compensation derived from Treasury Inflation-Protected Securities, at around 1.4 percent, remains notably
below pre-pandemic levels.
9
This evidence is also consistent with recent research by Baker and others, who examine a panel of
households using a financial planning app and show that these households responded quickly to CARES
Act (Coronavirus Aid, Relief, and Economic Security Act) stimulus payments despite stay-at-home orders
and social distancing; see Scott R. Baker, R.A. Farrokhnia, Steffen Meyer, Michaela Pagel, and
Constantine Yannelis (2020), "Income, Liquidity, and the Consumption Response to the 2020 Economic
Stimulus Payments," NBER Working Paper Series 27097 (Cambridge, Mass.: National Bureau of
Economic Research, May). Other recent studies, including Kargar and Rajan as well as Chetty and others,
find similar responses to the CARES Act using different data. See Ezra Karger and Aastha Rajan (2020),
"Heterogeneity in the Marginal Propensity to Consume: Evidence from Covid-19 Stimulus Payments,"
Working Paper Series 2020-15 (Chicago: Federal Reserve Bank of Chicago, May),
https://www.chicagofed.org/publications/working-papers/2020/2020-15; and Raj Chetty, John N.
Friedman, Nathaniel Hendren, Michael Stepner, and the Opportunity Insights Team (2020), "How Did
COVID-19 and Stabilization Policies Affect Spending and Employment? A New Real-Time Economic
Tracker Based on Private Sector Data," Opportunity Insights Working Paper (Cambridge, Mass.:
Opportunity Insights, May), https://opportunityinsights.org/wp-content/uploads/2020/05/tracker_paper.pdf.
Analysis by Bhutta and others uses data from the Survey of Consumer Finances to assess how the cash
assistance (expanded unemployment insurance benefits and stimulus payments) under the CARES Act
would help families cope with job loss and find that the CARES Act dramatically improves households'
financial security; see Neil Bhutta, Jacqueline Blair, Lisa J. Dettling, and Kevin B. Moore (2020),
"COVID-19, the CARES Act, and Families' Financial Security," working paper, July. The act's cash
assistance, in addition to families' liquid savings, would allow an estimated 94 percent of working families
to cover their recurring nondiscretionary expenses if they were to lose all of their income for six months
from April through September 2020. In contrast, in the absence of the CARES Act, only about half of
working families would be able to cover six months of expenses by relying exclusively on their liquid
savings and standard unemployment insurance benefits.
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the strength of the recovery will depend importantly on the timing, magnitude, and
distribution of additional fiscal support.
At the sectoral level, there is substantial heterogeneity in the effect of COVID.
Recent data suggest that the recoveries in sectors such as manufacturing, residential
construction, and consumer goods are likely to be relatively more resilient, while
consumer services are more likely to remain hostage to social distancing. Manufacturing
production jumped nearly 4 percent in May (following a historic drop in April), and
forward-looking indicators point to another solid increase in June. Pending home sales
and single-family permits rose more than anticipated in May. In the consumer sector, the
rebound in spending has been concentrated in goods categories-especially those sold
online-whereas most services categories have remained quite depressed. A similar
concern may apply to the commercial real estate (CRE) sector and to equipment
investment. Some parts of the CRE market-most notably, the lodging and retail
segment-are experiencing significant distress and have seen sharp increases in
delinquency rates along with tighter bank lending standards. For equipment investment,
production and supply chain disruptions and high levels of uncertainty continue to weigh
on expenditures.
In addition to the headwinds facing demand, there could be persistent effects on
the supply side of the economy. The cross-border distancing associated with the virus
raises the possibility of persistent changes to global supply chains. Within the U.S.
economy, the virus may cause durable changes to business models in a variety of
activities, resulting in greater reliance on remote work, reductions in nonessential travel,
and changes to CRE usage and valuations.
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In downside scenarios, there could be some persistent damage to the productive
capacity of the economy from the loss of valuable employment relationships, depressed
investment, and the destruction of intangible business capital. A wave of insolvencies is
possible. As the Federal Reserve Board's May Financial Stability Report highlighted,
the nonfinancial business sector started the year with historically elevated levels of
debt.10 Already this year, we have seen about $800 billion in downgrades of investment-
grade debt and $55 billion in corporate defaults-a faster pace than in the initial months
of the Global Financial Crisis. Several measures of default probabilities are somewhat
elevated. It remains vitally important to make our emergency credit facilities as broadly
accessible as we can in order to avoid the costly insolvencies of otherwise viable
employers and the associated hardship from permanent layoffs.
Finally, in keeping with the global nature of the pandemic, foreign developments
could impinge on the U.S. recovery. The International Monetary Fund estimates that real
global gross domestic product dropped at an annual rate of about 18 percent in the second
quarter after falling nearly 13 percent in the first quarter. While the potential for a fiscal
response across the euro area is positive and important, there has been some renewal of
tensions between the United States and China, and the outlook for many emerging
markets remains fragile.
The Federal Reserve moved rapidly and aggressively to restore the normal
functioning of markets and the flow of credit to households and businesses. The forceful
response was appropriate in light of the extraordinary nature of the crisis and the
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importance of minimizing harm to the livelihoods of so many Americans. With the
restoration of smooth market functioning and credit flows, our emergency facilities are
appropriately moving into the background, providing confidence that they remain
available as an insurance policy if storm clouds again move in.
While it is welcome news that 7.5 million jobs were added in the past two
months, it is critical to stay the course in light of the remaining 14.7 million job losses
that have not been restored since the COVID crisis started. The healing in the labor
market is likely to take some time. Last month, a majority of Federal Open Market
Committee (FOMC) participants indicated they expect economic activity to decline
notably this year and recover only gradually over the following two years. A majority of
FOMC participants indicated that they expect core inflation to remain below our
2 percent objective and employment to fall short of its maximum level at least through
the end of 2022.
Looking ahead, it will be important for monetary policy to pivot from
stabilization to accommodation by supporting a full recovery in employment and
returning inflation to its 2 percent objective on a sustained basis. As we move to the next
phase of monetary policy, we will be guided not only by the exigencies of the COVID
crisis, but also by our evolving understanding of the key longer-run features of the
economy, so as to avoid the premature withdrawal of necessary support. Because the
long-run neutral rate of interest is quite low by historical standards, there is less room to
cut the policy rate in order to cushion the economy from COVID and other shocks. The
likelihood that the policy rate is at the lower bound more frequently risks eroding
expected and actual inflation, which could further compress the room to cut nominal
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interest rates in a downward spiral. With underlying inflation running below 2 percent
for many years and COVID contributing to a further decline, it is important that monetary
policy support inflation expectations that are consistent with inflation centered on 2
percent over time. And with inflation exhibiting low sensitivity to labor market tightness,
policy should not preemptively withdraw support based on a historically steeper Phillips
curve that is not currently in evidence. Instead, policy should seek to achieve
employment outcomes with the kind of breadth and depth that were only achieved late in
the previous recovery.11
With the policy rate constrained by the effective lower bound, forward guidance
constitutes a vital way to provide the necessary accommodation. For instance, research
suggests that refraining from liftoff until inflation reaches 2 percent could lead to some
modest temporary overshooting, which would help offset the previous
underperformance.12 Balance sheet policies can help extend accommodation by more
directly influencing the interest rates that are relevant for household and business
borrowing and investment.
Forward guidance and asset purchases were road-tested in the previous crisis, so
there is a high degree of familiarity with their use. Given the downside risks to the
outlook, there may come a time when it is helpful to reinforce the credibility of forward
guidance and lessen the burden on the balance sheet with the addition of targets on the
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short-to-medium end of the yield curve.13 Given the lack of familiarity with front-end
yield curve targets in the United States, such an approach would likely come into focus
only after additional analysis and discussion.
The Federal Reserve remains actively committed to supporting the flow of credit
to households and businesses and providing a backstop if downside risks materialize.
With a dense fog of COVID-related uncertainty shrouding the outlook, the recovery
likely will face headwinds for some time, calling for a sustained commitment to
accommodation, along with additional fiscal support.