Fiscal Policy Stalemate Adds Pressure on the Federal Reserve

August 19, 2020

Fiscal Policy Stalemate Adds Pressure on the Federal Reserve Photo

Financial markets managed to shrug off the decision by Congress to leave Washington, D.C., last week without passage of additional coronavirus relief. The rise in stock prices, Treasury bond yields and breakeven inflation rates all suggested better news ahead on economic growth and inflation. President Trump’s executive orders to extend unemployment benefits, defer student loan debt, place a moratorium on evictions and offer payroll tax relief will help, if implemented, but offer a substantially smaller fiscal boost than the new relief packages under consideration by Congress. 

Despite the resiliency of financial markets, Federal Reserve (Fed) Chair Jerome Powell had to be disappointed by the lack of progress on a new round of fiscal stimulus. Since the forced shutdown of the economy in early March, he has emphasized the importance of the Fed’s lending powers working together with elected officials’ spending power in order to limit permanent damage to the U.S. economy. While recent signs of strength in labor market conditions are encouraging, the unemployment rate remains above 10%. Maximum sustainable employment, one of the Fed’s dual-mandate goals, remains a far way off.

This week’s release of the July Federal Open Market Committee meeting minutes is expected to shed light not only on the pace of the economic recovery, but also on the possible changes to the Fed’s other dual-mandate goal — price stability. Our Monday Morning O’Malley post this week highlighted the potential impact of Fed policy changing to price-level targeting (as opposed to inflation targeting), which will allow for inflation to run above the Fed’s 2% targeted rate. The change may appear to be subtle, but the implications for long-term Treasury yields are likely to be significant over the next few years.

The path forward for both the U.S. and global economies remains tied to the coronavirus pandemic and measures to control its spread. Reopening setbacks across the country have negatively impacted recent data on economic mobility and consumer spending. Even though the liquidity-fueled rally in financial assets may give politicians cover to hold their ground on new fiscal stimulus, any sign of more damage to the real economy from the coronavirus may force a shortened August recess for Congress.

Tags: Federal Reserve | FOMC minutes | Stimulus | economic recovery | Coronavirus

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