Mar 18, 2020

Claudia Sahm on Direct Payments to Individuals and Other Policy Responses to the COVID-19 Crisis

Sending direct payments to individuals may be the most crucial and immediate step the government can take to soften the blow of the coronavirus crisis.
David Beckworth Senior Research Fellow , Claudia Sahm

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Claudia Sahm is the Director of Macroeconomic Policy at the Washington Center for Equitable Growth and formerly was a section chief at the Board of Governors of the Federal Reserve System. Claudia specializes in macroeconomics and household finance, and joins the show today to talk about what the Fed has recently done and what fiscal policy can do in response to the economic meltdown caused by COVID-19. Specifically, David and Claudia discuss sending out direct payments to individuals, what the Fed’s remaining toolkit may look like, and how the freshly minted Sahm Rule may be of paramount importance as this crisis continues to develop.

Today’s show with Claudia Sahm is another installment as a part of an ongoing series regarding what the coronavirus means for the economy and for policy. The episode was recorded two days ago, and since then Treasury Secretary Steve Mnuchin has announced that payments will be sent to households in a few weeks, as a growing number of Republican and Democratic senators also pushed for economic relief. This topic is discussed at length throughout this episode, and the Mercatus Center will also be publishing a new policy brief by David Beckworth on cash payments to the public. This policy brief will be added to the show notes upon release.

David Beckworth: Our guest today is Claudia Sahm. Claudia is the director of macroeconomic policy at the Washington Center for Equitable Growth, and formerly was a section chief at the Board of Governors of the Federal Reserve System. Claudia specializes in macroeconomics and household finance, and joins us today to discuss what the Fed has done and what can be done in fiscal policy in response to the economic meltdown caused by the coronavirus. Claudia, welcome back to the show.

Claudia Sahm: Thank you, I appreciate the chance to come back.

Beckworth: I'm glad to have you back on. I wish it were under better circumstances, in terms of the economic environment around us. Very dire times, indeed. Schools are closing, travel is shutting down, people are beginning to lose their jobs, trade is collapsing, entire country is on lockdown. We may be a few weeks behind, at least here in the U.S. We're recording this on March 16th and it will come out in a few days from now. Even today, the stock market hit a record, I believe, third worst day since 1987.

Sahm: The second, second worst.

Beckworth: Second worst day, yeah. So, quite a turn of events over the past few weeks. We've had a few episodes so far on this virus, its consequences for the economy. Just in general, stock markets are down, oil prices are down, treasuries are down. Everything seems to be down, and the outlook is dire. So, a lot of change is happening, and I think both you and I are fortunate in the sense we have jobs where we can fairly easily go home and work. I think our employment is fairly secure, but there's a lot of people out there who may not be so fortunate, people in the service sector, people in retail who may find it much harder to cope. I want to talk about what we could do for them in terms of policy, but I'm just curious, Claudia, how are you adapting to this? I mean, are you working from home? How are your kids adapting? What's going on in your world?

Sahm: So, I mean, we're adapting on a lot of different levels, some more gracefully than others. So, I have been working from home pretty steadily since the middle of last week. There's growing pains, getting the technology, getting the Skype, the Zoom to work, the phone calls. Frankly, it's hard to do work without somebody down the hall to just check in, especially when we are having such trying times, right. So, there's that piece, but I think, I mean, we're adapting, like you said. We have good jobs, I have the capacity to work from home. I mean, sometimes I'm even more productive at home than in the office. So, that's tough, but it's not as tough as a lot of people are facing right now. So, as a parent, so I have two children, my son's in fourth grade and my daughter is a teenager.

Sahm: Today was their first day out of school. The fourth grade son is getting a lot of YouTube education about Pokémon, though I try when I get a break, to get him off and reading a book. One thing about that, though, I will say at a time like this, we really need to take care of ourselves and we need to take care of the people around us. Last week when I took my son to his regular check-up with his therapist, she asked... and I said he’s at school, everybody was washing hands twice a day, and we talked about the coronavirus, I had with him before. His doctor said, "Have you asked him how he felt about it?" So, we asked Henry and he said, "Well, a lot of people are getting sick and this is a threat to humanity," and I was like, "Whoa."

Beckworth: That was pretty heavy.

Sahm: So, he didn't really know what that meant, he reads a lot of fantasy-fiction and stuff. So, I think that's the thing, is we really do need to talk to each other. Everybody handles crisis differently, so it was a real reminder to me. I've tried really hard with colleagues, especially junior ones, and on Twitter, too, to be like, "We can do this." I will say that I'm drawing on experience, I mean, not just as a mom, but when I worked at the Federal Reserve, so I was there, I was a brand-new economist early in 2008, I saw the recession start up, the financial crisis, especially in the Fall of 2008. There were some very scary times, even within the board just trying to catch up and understand and give good advice to the policymakers.

Sahm: I can remember our division director, Dave Stockton, at the time, giving a very clear message to the staff that we had to put our heads down and do the work. We knew how to do the work, it was a not a time to panic, panicking would do nothing to help the situation, and we just had to do our job. So, I've been thinking a lot about that today, because it is, well, frankly, less, three weeks I've been thinking about it. Definitely Sunday night when the Fed came out and brought out the big guns, and the markets still went down the limit, and we still don't have a concerted, large, fast-acting fiscal stimulus package. Watching, like I said, the market drop further today is really hard. I look at all this and I know where this is going, and this is very bad.

Sahm: Yet, me freaking out about it, me freaking other people out about it, is going to do absolutely no good. We are in damage control, we can control damage, and we're going to make it through. Americans, people are the world, we're very creative and we're a hardy bunch. We'll get to the other side, but I am very concerned about the public health, economic, and frankly, we're getting to straining the social fabric. So, we have to take this very seriously, but people are, everybody is waking up. This is a big deal.

Yet, me freaking out about it, me freaking other people out about it, is going to do absolutely no good. We are in damage control, we can control damage, and we're going to make it through. Americans, people are the world, we're very creative and we're a hardy bunch. We'll get to the other side, but I am very concerned about the public health, economic, and frankly, we're getting to straining the social fabric. So, we have to take this very seriously, but people are, everybody is waking up. This is a big deal.

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Beckworth: I agree this be a very formative experience for many people, especially young people. Children, they'll remember this as a very unique time in their life, kind of like my age group. I remember the Challenger, nothing quite like this, probably, but there's all these formative experiences, or maybe if you're a millennial, you'll remember 9/11 as a very pivotal development or shock in your life. Even today, I was watching the news conference and I sensed a difference in President Trump's demeanor and his response. He got much more concerned, his answers were much more sober. Even in some of the journalists, I remember one of the journalists asking him, "How long is this going to last?" He said, "I think it could be through July or August," and you could see their jaws drop, if it takes that long to get to the worst of it.

Beckworth: So, this has the potential to be a very sharp recession, and it's, in some ways, different or maybe even worse than the great recession in terms of maybe a short-term severity. Now, we do know there's a light at the end of the tunnel, that this will eventually end because we know eventually, public health with improve and the economy will recover. Between now and then, it could be very sharp in terms of the amount of economic loss and harm done to public health and to the economy.

Sahm: If I could just amplify for a second, I mean, like I said, having had my birth as a macroeconomic forecaster during the great recession, financial crisis, and frankly, a very formative experience for me, was watching the slow recovery. That was a very painful recovery. So, when I look at where the world is moving... and I was happy you said, "We're recording this on March 16th," because every single day, and frankly, hour-by-hour, I'm mentally updating my macro forecast in my head. I think, well, first of all, a preface that anyone who tells you that they know what's going to happen, even next week, let alone six months from now, no one can know that, right. All of us, including people, just lots of people out in the world, we're all trying to form some kind of expectation.

Sahm: What do we think's going to happen and how should we best prepare for it? When I look at everything coming together, I really feel like this is at least twice as severe as the Great Recession, in terms of the contraction that we're going to see. We have economic activity in the United States shutting down. Jason Furman made this point in the op-ed last week in the Wall Street Journal, he said, "Even at the peak of the great recession, we had 10% of labor force unemployed." We are going to have 75%, 80% of the U.S. population at home, or constrained in some... we have entire cities, San Francisco just locked itself down. I mean, this is really widespread. So, I agree with you, I think in that severity, like the hit in the second quarter, stretching, I agree with President Trump, there's dislocation to the summer.

Sahm: So, that's a huge concern, and we have to act fast and go big on this. What I learned from the Great Recession is that the economic damage will last much longer than the shock that took us into the recession. So, in 2008, that was the housing markets, mortgage-backed securities. This time, it is a virus, the coronavirus, we'll beat this thing and the public health crisis will pass, and we will have lingering effects for years. For the people hardest hit, their entire careers and lifetimes are going to be negatively affected by this event. I think that's a real concern for me, the United States does not have a strong social safety net, far weaker than our counterparts in other developed countries. Vast majority of Americans, all the way up to the upper middle-class, many of them have thin financial buffers and have never been ready for a recession, and we are really never ready for a recession that looks like the one that's gaining steam.

The United States does not have a strong social safety net, far weaker than our counterparts in other developed countries. Vast majority of Americans, all the way up to the upper middle-class, many of them have thin financial buffers and have never been ready for a recession, and we are really never ready for a recession that looks like the one that's gaining steam.

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Sahm: So, that's why I said, we just got to mitigate the damage, enhance the social safety net, get really creative about how to get support out, and absolutely commit to staying the course. This whole policy pulled off way too early in the great recession and that, we just cannot do that again. That was very damaging.

Beckworth: So, I want to come back to the fiscal policy response in a few minutes, but just again to echo what you said, we are literally bringing the U.S. economy to a full stop. Imagine driving the vehicle, it’s the economy, and then hitting the brakes. That's what's happening, so in some ways, it is far more severe than what happened in 2008. Again, the upshot is, once we get past all of this, we will hopefully get back to something similar. We haven't, hopefully, lost permanently any capacity, though there will be people, like you said, who do suffer damage that may never come out of it. So, it's important to respond fast and hard today, and speaking of that, I want to talk about some of the proposals we've seen today. We will get the Fed policy and what can be done there, but I want to talk about some of the developments we saw today.

Beckworth: Senator Mitt Romney came out and suggested everyone get a check of $1,000 each month until this crisis gets over. So, for example, if the worse part does go through July or August, we'd each get checks during that period. Some others have come out and started that, and I believe that's kind of the spirit we're seeing now and kind of a movement towards getting money directly towards households. Do you think that's the right direction? The right way to go in this crisis?

Direct Payments to Individuals and Other Policy Responses

Sahm: So, I think, and this is true in any recession, we need to be in the “and both” spirit when we construct the economic policy. That's true about bringing in the fiscal policy and the monetary policy, and whatever else we can come up with. Frankly, the fiscal policy should be coming from state and local governments, too. So, this is not a time to try to pick across policies. We want to design any policy we do to be as effective as possible, but we do not want to put all our eggs in one basket. That was a really important lesson from the Great Recession, the American Recovery and Reinvestment Act threw a lot of policies at the Great Recession. Some of them were really effective, like the increase in federal funding through Medicaid, which is referred to as a F-MAP, that was really effective to get money to states, and they needed the money because they were hitting balanced budget requirements.

Sahm: Other stimulus, the way that the money that went to individuals through the Making Work Pay Tax Credit, it was spread out over time and ended up being small dollar amounts. People didn't notice, and frankly, they needed it right away, right. So, there were some policies that worked really well, there were some that weren't, didn't. So, that's why it's really important to think of a whole range of policies. So, I think that payments to individuals, broad-based, just get the money out, it has a number of features that are useful. One is being macro, you can pump a lot of money into the economy that way and very fast, any of these social safety nets, and it is absolutely crucial that we shore up unemployment insurance, food stamps, TANF. Anything that's a part of the social safety net, those benefits need to go up now.

It is absolutely crucial that we shore up unemployment insurance, food stamps, TANF. Anything that's a part of the social safety net, those benefits need to go up now.

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Sahm: And extensions, making it more easy for people to get on the rolls. A lot of those programs, like the unemployment insurance, in terms of putting dollars into the economy, that doesn't happen out of the gate. I mean, people are losing jobs right now, but we're not going to be at 10% unemployment for months. That unemployment rate always peaks after. So, we have to think, it's really important to have that support, is so important to help people who are directly hit, but right now, we got to get the money out. We don't know who is going to lose their jobs, we do not know who is going to get sick. People don't know that either, so I mean, they're pulling back, they're trying to figure out what to do. Giving them a little bit of a buffer...

Sahm: $1,000 will not cut it if you lose your job, but $1,000, frankly, is more of a financial buffer than a lot of U.S. households have. So, get some help out, get it out fast. This is a lot of money, but pair it. Don't just do that. In 2008, there was kind of this one-off, here's a stimulus payment. We needed more, right. So, we've had a lot of lessons, we can put it together, but it's going to-

$1,000 will not cut it if you lose your job, but $1,000, frankly, is more of a financial buffer than a lot of U.S. households have. So, get some help out, get it out fast. This is a lot of money, but pair it.

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Beckworth: Need to be done right.

Sahm: ... a whole array of polices.

Beckworth: Yeah, a whole array and it needs to be done right. I want to go back to this idea that the payment to households, so the checks that go out, needs to be conditioned on what's actually happening to the households in general. So, something I have proposed, and I think you, too, in your famous Sahm Rule, is you send those checks, conditional on the state of the economy. So, if households are suffering, if we think they are, if there's some way they find an indicator that represents that, we send the checks until things do look better, until we're out of the woods. I think another thing is that we just send them out, we don't try to discriminate, because it's going to be too hard, which household needs it more than the other.

Beckworth: We just have to send them out, because households are churning, who needs it, who doesn't, changes all the time. We just got to do kind of a blitzkrieg of sending the checks out.

Sahm: I totally agree with this. Just to underscore the point, I think targeting on the front-end, right, so targeting before we know who's going to get the hardest, for example, having bigger checks go to lower income households, I think that kind of targeting is very hard to do and do correctly, because we really don't know. Some low-income households, maybe they're a social security recipient and they've saved a lot of money, they don't have wage income coming in, but they've got a buffer, right. So, it's going to be really hard to pick who needs the support most, to just upfront, give everybody a cushion. On the back-end, when we see the distress, when we see people getting sick, when we see people losing their jobs, then you target. Don't target on the front-end. If you get fancy, it's going to slow you down.

Sahm: I spend a lot of time talking about we cannot let the perfect be the enemy of the good.

Beckworth: That's great.

Sahm: We have got to move, and it'll be messy. It's not going to be perfect, but frankly, we don't have time. This is not our only... this is like a frontline. What I'm talking about with the direct payments, this is a frontline, we have to have a much more, not just array of policies, but a commitment to keep at it. I think to one point that I did want to... there's a couple things about the automatic stabilizers, and I've gotten questions. People are like, "Well, but the Sahm Rule hasn't triggered, should we wait?" And I was like, "Oh my gosh, no." I was like, "Just pick your head up and look at the world." The stock market is in free-fall, cities are shutting down, countries have shut down ahead of us, and people are already losing their jobs. I was like, "I don't need the Sahm Rule to tell me that we're in recession."

Sahm: The Sahm Rule has never triggered in the first month of a recession, which is technically the peak. I really think March of 2020 is the highest economic activity that we're going to see for a while.

Beckworth: That's the peak.

Sahm: So, the peak of the expansion is when the recession begins, downhill from here for a while. Recessions end. So, the thing was, is I see the Sahm Rule, for any kind of automatic trigger on and trigger off, as a backstop, right? So, in 2008, when the Sahm Rule turned on in March of 2008, it was not widely accepted or believed that we were in a recession.

Sahm: The Fed was actually... When I was there, Dave Stockton actually turned the recession call on March of 2008. Our forecast meetings went to invite only and these were staff. This wasn't in the FOMC. They went to invite only. We were instructed not to say the R word, recession, in the building, because it was not a widely held view outside the Fed. That's why I said last night, it was a big deal for Chairman Powell to say economic activity is going to contract next quarter. We didn't do that in 2008 because we didn't want to freak out the markets in March. We put the recession call in in March. It came back out in April, before the FOMC meeting. It went back in June, it never came out again. That was a time where the Sahm Rule really would have been, "Let's go. We are in this."

Sahm: Now, this time, we don't need that. I think it should be there. I don't want to slow the process down, but I think this could be a very important opportunity to build in in the legislation that's happening, automatic turn-ons like backstops, and maybe even we use that as a second round that still goes out. If this summer the unemployment rate does what I think it will, and it starts moving up notably, be ready to go with a second check or an extra bump up to safety net benefits. What is really important, and I have been working hard on ... The Sahm Rule is a trigger on. I've been working very hard over the last few weeks on triggers off. I'm really happy with where it's at right now. You need to have something that upfront right now, when Congress passes legislation they say, "We will keep these stimulus programs going until the labor market improves."

Sahm: Now, it’s a question, and what I'm doing with the triggers, not surprising because I think the unemployment rate is such a good way to summarize what's happening in the economy is looking, okay, is the unemployed rate falling? And you definitely want to look at this after it's peaked, and then how close is the current unemployment rate or the unemployment rate at this time in the future, to the unemployment rate right before the trigger happened, right before the Sahm Rule trigger?

Sahm: And you can think about, if you want to get within one percentage point, you're going to run those benefits a while, but maybe two and a half percent is okay. But you want something so Congress has a sense of, "Okay, this is what we're committing to doing." Now they can always ... Congress is an elected body. They can do what they want to do, they don't have to wait for the Sahm Rule trigger, they can send out payments now. If you get out in two and a half percent unemployment, still looks like a lot of dislocation, you can keep them running. But I think this is one thing we learned in the great ... Well, we learned a lot of things, but one of the things we learned in the recovery is that the commitment wanes, the budget deficit, these numbers are going to add up.

Beckworth: So you need to have the rule in place prior to engaging in this operation?

Sahm: Yes.

Beckworth: And I completely agree. You need to have the rule to create predictability, to help households feel confident about the future, to put constraints on Congress for that matter as well, that they will turn it off once we get to the point where the labor market, the economy is doing well. And I completely agree with you. One of my ideas, proposals is to tie these checks, no matter how they're dispersed, to some measure of household income, some measure of household economic outlook. And I think just having those dashboard indicators in front of us, if everyone understood them, it'd be very useful. Congress, the public, listeners of the show, just in general getting the message out that we're committed to do whatever it takes until these indicators improve.

Sahm: Yeah, no, and I think, yes, totally. We need a commitment that has a very good ... part of it's communication, so telling people the government has your back. We are asking you to do things like wash your hands, help take care of other people, stay at home, don't spread the disease, but they need to hear that the government is doing a lot. The government is doing a lot in public health space and the government is doing a lot to make sure that families get back on their feet. So it's important to say that. Commitments we will stay the course are a good way to help convey that and convince people, but you cannot just have words. There has to be money and there has to be effective policies.

We need a commitment that has a very good...part of it's communication, so telling people the government has your back. We are asking you to do things like wash your hands, help take care of other people, stay at home, don't spread the disease, but they need to hear that the government is doing a lot. The government is doing a lot in public health space and the government is doing a lot to make sure that families get back on their feet. So it's important to say that.

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Sahm: So this is where [you should be] pairing it. Get it out of the gate, get big money, get money in people's pockets, make sure they know about it and then tell them if this is severe, we're going to keep doing this. Every year, we're going to send out these payments. Every year, we're going to keep the extra unemployment benefits. The extended benefits, the food stamps ... We're going to keep all of this going until things get better. But you can't just say it, you got to do it.

Beckworth: Right, right. So you want some kind of legislation, some kind of policy enacted that ties a specific amount of money to a specific indicator or rule? So I'm sympathetic to that. Again, it's good for communication, for managing expectations, for also tying the hands of Congress in both a good and bad way. But let me ask you this, how regularly should those checks go out? Do you have a sense of that? Mitt Romney suggested $1000. $1000 every month until we have a recovery in hand or every quarter. What should happen?

Sahm: Yeah. So I haven't looked at Romney's proposal carefully, but I thought it was a one-time $1000. But if it's $1000 a month, thumbs up. But I think there's a ... We need to get it out. I think in my proposal, in the chapter, the recession ready…

Beckworth: This is the Sahm Rule proposal now right?

Sahm: The Sahm Rule.

Beckworth: Okay.

Sahm: That once the Sahm Rule triggered, you'd get a check out. Frankly, I think we could do two checks this year. So get the checks out now get the checks out again when the Sahm rule triggers. Then what I said in the proposal, and this was very specifically to thinking about the Great Recession, is if it is a severe recession, the benchmark I use for that is the unemployment rate rises two percentage points or more in the first year. If that happens, so in the years from which the Sahm Rule payments go out, then you repeat them and you repeat them every year until you get this trigger off, like the unemployment rate comes down, and you can decide what that exactly is.

Sahm: So that's a commitment to have those payments go out, and running alongside that, that's where you have the extra amounts in the weekly unemployment insurance, the extended benefit. There ought to be, you can have a whole host of stimulus that runs inside of this.

Beckworth: So in your-

Sahm: Does that make sense?

Beckworth: Yeah. In your vision, you're saying you have this one big check that goes out and then you have all these other supplemental funds that go out through different programs. And then every year, another check could go out if the market, if conditions are still in a bad place until we see recovery?

Sahm: Yes, and severe recessions ... We don't ... This is not every recession, right? So-

Beckworth: But this is an exceptional recession it seems like, yeah.

Sahm: This is, by the criteria I use, this is the '74, '75, the '81, '82 and the 2008, 2009. Those are the three since the 1970s that are big.

Beckworth: Yup.

Sahm: So, that's-

Beckworth: And this is likely to be larger. Again, we're bringing the economy to a full stop. We had this discussion, I don't know, two, three weeks ago. Is this a supply shock or a demand shock? It almost seems silly now given what we've seen happen since then. But just a textbook discussion, you'd say, "Look. Well it is a supply shock. We've disrupted the productive capacity of the economy." But on top of that, we've seen the stock market decline almost 30% since its peak, and we know if that happens, it lowers the wealth of households which then lowers spending. We also know there's a high level of uncertainty which causes business to put off any kind of investment spending. The low interest rates tend to increase real money demand, again lower spending.

Beckworth: So we have all these large spillover effects on the demand side as well as the supply side. And again, we are stopping the US economy, the global economy, in its tracks and we've never done that outside of wartime.

Sahm: Yep. Yeah. No and I think Olivier Blanchard on Twitter today, he likened it to fighting a war. We're fighting a war against the coronavirus. We are fighting tooth and nail to keep this recession, to damp it as much as possible. We're not going to stop this recession. We're not going to turn this recession into the 2001 recession that wasn't that severe. This is going to be a very severe recession. We have faced as a country and as many countries, very severe disruptions. A war is as close as ... That's a very good, I think analogy. The Great Depression was on that scale too, and that's the mindset we have to have. And the thing I applaud Olivier Blanchard for bringing up, he's like, "In times of war, the budget deficit, we just set it aside." It got really high relative to GDP and that's okay.

Sahm: We shouldn't be doing that in normal times, but this is absolutely not the time to worry about adding to the deficit. And it's notable because when he was the chief economist at the International Monetary Fund, when we got into the recovery and fighting the Great Recession was costing a lot of the government a lot of money and in countries across the world, he was part of ... There was a whole group of academic economists and policymakers that said, "Whoa, this is getting too much," and advocated for pulling back on the stimulus. Olivier has come out since and said he was wrong. He understands the situation and so I was very happy when I saw his tweet today because he is reinforcing that we need to go big and he wasn't comparing this to the Great Recession. He was comparing this to war times.

Sahm: So I think that that is the mindset. I feel you're seeing that the ... The world is changing very fast. Every day, every hour, and I take ... It is heartening to see people waking up and there is a chorus of voices that are saying, "It's now," and, well we can do this. We've done this before. This is not insurmountable, but this is a moment that's not like ... This is not business as usual.

Beckworth: It is heartening, but it's taken a good month to see a lot of people wake up and I can speak from personal experience. I won't mention any names-

Sahm: No, I think…

Beckworth: But people in my own community, people around where I live, it's been a bit of a struggle to convince them that this is more serious. It's not just a media generated panic. And for sure, we do overreact, we do race to grocery stores and hoard toilet paper foolishly. But in general, this is a very severe situation. I want to quote a comment by Derek Thompson, a great writer for the Atlantic on Twitter, he put this. It was a great way to illustrate how severe this could get, and he says, "This isn't like the great recession. In some ways it may be worse. It's a sudden stop, like a debilitating blizzard, except the snow storm is global. Some countries have run out of plows and the cold gives pneumonia to one to 10% of the population."

Beckworth: Okay Claudia. So Derek makes a compelling case that this is going to be a very severe recession. Do you have any other thoughts about the whole advanced warning where we were in the past compared to where we are today?

Learning From Past Recessions

Sahm: Right. So I find it frustrating. We're always going to refer to this as the Coronavirus recession. Frankly, I think that's giving too much credit to this virus. We had over six weeks notice of what was happening with this virus. We even three weeks ago, we should have seen, and frankly like you said, I missed some of the earliest signs. I can remember about three weeks ago, Tyler Cowen who is a complete germaphobe, started writing all these posts that were alarming about the Coronavirus. And I was like, "Could you just calm down? You're going to start a panic. We know how to do this health stuff."

Beckworth: Right. You're making it worse Tyler.

Sahm: But Tyler did point out about a week and a half ago that he was right and I was wrong. I was like whatever, but we had advanced warning. Even three weeks ago when it was clear in South Korea and when just as soon as we saw countries like China, the only way they were getting a handle on the problem was to basically shut down economic activity. It does not take a lot of imagination to think, "Oh wow. If that happens here, we are in big trouble." And we have less of a safety net and we have less coordination. There has been a degree of dysfunction in Washington for over a decade. So this is not ... We could have seen and I think frankly policymakers, people who have had a public voice trying to downplay this, they share some of the blame.

Sahm: Now is not the time to point fingers and I believe in redemption and we just need to roll up our sleeves, but we will need to learn something about structures both in the political… and we're also paying for a lot of structural imbalances in the economy. There's a lot of inequality. There's a lack of a safety net, there's a lot of concentration of power, whether it's in the corporate sector...we're paying for this now.

Now is not the time to point fingers and I believe in redemption and we just need to roll up our sleeves, but we will need to learn something about structures both in the political… and we're also paying for a lot of structural imbalances in the economy. There's a lot of inequality. There's a lack of a safety net, there's a lot of concentration of power, whether it's in the corporate sector...we're paying for this now.

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Sahm: So I think we had more advanced warning. It doesn't really matter right now. People are waking up and yay, we need to do that. I think there is still a waking up to how precarious the situation is. I think a lot of people were surprised about last night with the Fed. Frankly, I was surprised we hadn't gotten to zero last week, but we got there last night and that was big and bold and I know you want to talk about...

Beckworth: Yeah, let's-

Sahm: Monetary policy.

Beckworth: Yeah, let's move to the Fed's big bold decision from Sunday evening, which all of us were surprised and I think it was the right thing to do. But before we move on, just one last thought on what you just said. I agree it's been a lot of dysfunction. We've been very polarized in this country and who knows, maybe this will be what brings us closer together again. We'll pull down those divisions. We'll work together. This is a war of sorts, we're going to fight against the virus and we'll be unified in our efforts just like we were in previous wars. But yes, the Federal Reserve had some very bold actions last night and I'm going to summarize them here briefly. I'm going to pull from Tim Duy's excellent Fed Watch. If you don't subscribe to that, please do. He's on Twitter as well. He's a friend of the show. He has been on here a few times and a friend of Claudia's and mine as well.

Beckworth: So just a quick summary. First, the Fed effectively cut interest rates to zero. They cut their range from zero to 0.25%. Effectively we're back at the lower bound, or at least the zero bound on interest rates. We might go lower than that. They provided strong forward guidance. They're going to hold rates at zero until they're confident the economy has weathered recent events and back on track the full employment. They have reintroduced quantitative easing, true QE. It's not to be confused with the other QE

Sahm: They don't call it that, but yeah. So whatever.

Beckworth: There's a lot of confusion over that because the Fed has been buying up treasury bills and such to help the plumbing of the financial system, but this is closer to the original QE. The discount rate was lowered, intraday credit was encouraged, loan guidance, reserve requirements were cut and just in general, very bold statement. Now unfortunately, the market was not convinced. It continued to fall the next day, today, and in fact, today they had to pull the trigger where they had the circuit breaker on. Again, as we mentioned, this is one of the biggest losses in one day on the stock market. So despite pulling out the big guns, the markets still had a very rough day today and that's just wealth being destroyed. Again, that's spending that won't take place in the future, even in the present. So again, it means more and more contraction of  economic activity.

Beckworth: So the Fed came out blazing last night Claudia, pulled out the big guns. So my question is do they have any big guns left? So we know Congress, as we talked about, can do some big things. They can send checks out, they can supplement existing social safety net programs, but let's talk about the Fed's toolbox. What is left in the Fed's toolbox? And the reason I ask this is because one, they've lowered interest rates to 0%, at least the short term ones, and they don't seem particularly interested in going negative. And even if they did go negative, there's not a whole lot they can do there. There's some lower bound where people would rather hold cash than some large negative interest rates.

Beckworth: So there's only a little bit more they can do in terms of lowering rates on the short end, and that also seems to be the case in the long end. So if they do QE or a yield curve control, there's not a whole lot of interest rate space left for them to do. Now there's other things they can do. They can buy municipal bonds. Skanda Amarnath has had a proposal out which could provide funding to state and local governments. Legally, they can do this. They have the currency swap lines with other countries because dollars will probably be highly demanded as this gets worse. But it seems like, at least on the surface, its toolbox is getting smaller and smaller, or alternatively, there's fewer tools left in the toolbox. So any thoughts on what the Fed can do or am I just not giving enough credit to what's left in the toolbox?

What are the Fed’s Remaining Policy Options?

Sahm:  Yeah. I have to say, David, you're usually the optimist, but I'm going to counter this. So I understand where it's coming from. I find the narrative or even the point of view ... Let's put stories aside, the Fed is out of ammo or the Fed's toolbox is empty or becoming empty fast.

Sahm: I was extremely frustrated last week, maybe it was two weeks ago when Larry Summers had an op-ed in the Washington Post and he, in his opinion, the Fed should not cut further. This was after they'd done the 50 basis point cut. He didn't want them to take the other hundred off the table. He said the Fed needs ammo and I feel very strongly that that is not the right approach. We have ammo for this very reason.

Beckworth: I agree with that.

Sahm: The flip side of this is I think Larry and a lot of others are being not creative enough in thinking about what the Fed will put in its toolbox. Okay. Remember when the Fed took interest rates to zero for the first time ever in 2008, most of us would look at that and say, oh wow, we're done.

Sahm: That's what they do. And they just stopped. Okay. In the years after that, and frankly in the months after that, we saw the Fed get really creative. Now they've paid a price. So when they use their emergency lending powers and 13(3) it's 13(3)(c) is the very specific clause. When they did that, and I think it's really important to go back and think about the context. I can remember sitting at my desk watching the emergency lending, the bailout go up to Congress, in 2008 Congress voted it down. I mean I saw it on my screen. I was thinking “I cannot believe you just voted that down.” The Fed stepped in very soon thereafter and they did the bailout. This is highly problematic. They had to do it, the financial sector was going to go over the edge.

Sahm: This is very bad. Wall Street, for all its flaws, we need it. You can't let it go under, but the Fed when they did that, they very specifically didn't … they violated the spirit of something a body of elected officials had said, we don't want to do, and the Fed did it. In Dodd-Frank, it is not surprising that those powers were taken away. They have to get Treasury’s thumbs up. They would not have gotten that in 2008 because Congress didn't want it, the administration didn't want it. So that's an example. I think that is the most poignant example of the Fed got really creative. Like I'm sure there were attorneys at the Fed working overtime trying to find anything-

Beckworth: That's why you hire lawyers.

Sahm: That wouldn't be an egregious illegal use of Fed power. But we saw, they did quantitative easing, they've tried valiantly to do communication… this not something economists should be entrusted with, but they've talked about and they've been doing a framework review like they embrace the fact that they need to expand the toolbox.

Sahm: I am confident that they are working 24/7 to figure out how to expand the toolbox just like they did in 2008 and 2009. I understand there are limits. Most of the tools the Fed has, I mean the Fed works through financial markets. It works through nudging interest rates and maybe asset prices. The interest rates, they were low before the Fed did the first cut three weeks ago. So people, it's a cash flow issue. If people aren't spending, if businesses aren't investing, if state and local governments aren't running their programs, it's not that the interest rates are too low and they can't borrow. It's because they don't have any money. I mean in a very Fed speaking way, I mean since Bernanke was chaired, they've basically been yelling at Congress like, please do something, do your job. Or they can't tell Congress how to do their job, they can't give them pointers.

I am confident that they are working 24/7 to figure out how to expand the toolbox just like they did in 2008 and 2009. If people aren't spending, if businesses aren't investing, if state and local governments aren't running their programs, it's not that the interest rates are too low and they can't borrow.

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Beckworth: If they want to maintain their independence for sure.

Sahm: Yeah, and it's Congress's job. In a sense that they're also entrusted with this responsibility. The Fed is not elected by the people. The Fed does not get to decide how large sums of money are directly sent out and spent. Totally understand, but the Fed understands they can't do it alone. They have continued to point that, I mean, Congress and administration know deep down that the Fed can't do it alone. And what the Fed did yesterday on Sunday is that we're giving you all we got. Even in our unconventional toolbox. We'll keep working on it, we'll get more tools, we'll push it. And you're right. They have some tools that they like less than others, like the negative interest rates. You know, Miles Kimball would not want me to say this, there are some very operational issues with doing that, but you know what? They're going to do whatever it takes.

Beckworth: Right.

Sahm: I think there are some tools they have never used and I've talked online and in various forms about money financed fiscal policy, which is essentially fiscal policy that either the Fed does, I mean even academics don't talk about the Fed doing it alone. More common, the academic case is that the Fed finances the fiscal stimulus that goes out to Congress. The Fed puts it on the balance sheet, keeps it there. What's referred to as monetizing the debt so that it doesn't show up in the budget deficit for the country.

Beckworth: Yep. No, absolutely. And I like your point in my colleague Scott Summer will be very proud of you for pushing back against my defeatism and I was kind of playing it up to some extent. On one hand, you're absolutely right, there are many things the Fed could still do. I think in my view at least, one of the big things it could do is announce a level target. It could switch to a really firm makeup policy, whether it's a price level target or my favorite, I believe your favorite now, too nominal GDP level targeting, which aims to stabilize the nominal incomes of all Americans. I think that'd be a huge move, a beneficial move at this point in time. And in fact I would encourage Fed officials to move their announcement date up for that.

Beckworth: And you're right, they could do negative interest rates. It's true. And they could do yield curve control like during World War II where they effectively supported... So even if they run out of space on the yield curve, so the 10 year treasury goes to zero, they can still keep it, peg it there and allow Treasury to run large amounts of spending being financed directly by the Fed, which could be put to productive use. But I think first thing I would like them to do is move to a nominal GDP level target and then tweak with these other tools. The cynic in me though says, okay, fair. But ultimately a lot of these tools are all about tweaking interest rates, or pegging them and at some point you reach diminishing returns to that and we've kind of boxed ourselves into a corner because of the secular decline in interest rates.

Beckworth: And again, over the past three weeks or so, long-term rates have fallen. The Fed's been forced to cut the short term rates. And I think we may get to the point where the Fed does have to say, look, we've done all we can Congress and Mr. President, the ball is in your court. You now take the big move. And if Congress wants to give the Fed more power to do helicopter money as you propose and they should make it official, change a law, rewrite the Federal Reserve Act or if they want to do it themselves, they should do it. But I think we'll get to a place where we'll see out of necessity much more coordination between monetary policy and fiscal policy. My only hope is that going back to what we said earlier, it's done in a very predictable kind of rules based way with triggers, with signals that manage expectations that tend to calm markets as opposed to create uncertainty.

The Coordination Between Monetary and Fiscal Policy

Sahm: Yeah, no, and I absolutely agree if there's any kind of coordination between the Fed and the administration in Congress, like in terms of the Fed helping finance or even like you said, helping hold interest rates down, long-term interest rates down so that it's cheaper for Congress to do the kind of fiscal stimulus. If we get to that point. It absolutely has to be based on some kind of a rule. And that is a very dangerous situation for either the Fed to have discretion, they are not elected officials, or for Congress to have the discretion and then the Fed has to follow along and we have a long history in the United States and other countries. Once this starts happening where the President tells the Fed what to do and the Fed listens…but if the Fed listens and they are working together, the incentives, the goals of those, the responsibility of those two organizations are not the same.

That is a very dangerous situation for either the Fed to have discretion, they are not elected officials, or for Congress to have the discretion and then the Fed has to follow along and we have a long history in the United States and other countries. Once this starts happening where the President tells the Fed what to do and the Fed listens…but if the Fed listens and they are working together, the incentives, the goals of those, the responsibility of those two organizations are not the same.

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Beckworth: That's right.

Sahm: When they become aligned, we have seen a lot of problems. Right? So I'm very uncomfortable with us getting to that kind of coordination where there aren't rules, rules that nobody can game, like good luck gaming the unemployment rate, the people at those agencies, I mean they would like full on revolt if you tried to get in there and mess around with those numbers. So you'd need to have rules. But even if we had that, it would be such a level of dysfunction if we have not been able to have monetary policies separate from fiscal policy. That would say so much about what has happened in our policy making environment in DC. That just to me, I don't want to go there because it's mixing, I mean I've said it more than once. It's mixing people who are elected, who are accountable to the American people with people who are not elected. They are not accountable. They do their best. They try really hard. They do their job the best of their ability that they do not answer to the American people. It's all kinds of wrong.

Beckworth: Yeah. So you don't want to give them a whole lot of power since they're not really accountable directly to the public. On the other hand though, the danger is you have Congress who is accountable and maybe they want to game it up so they get re-elected. So there's a juggling act we got to do here.

Sahm: Think about it, how we have Federalism in general, you have a Federal government, you have strong state and local governments, which frankly, I mean I should note the state and local governments are the ones really stepping up to the plate. We are seeing some really innovative, creative, forceful, bold responses to the Coronavirus at state and local governments. They are not waiting for the Federal government to get its act together. So just like in terms of on the fiscal [side], we've got the distribution of powers, right? And the President and Congress and the judiciary, there's all of that, well the Fed really fits in that system.

Sahm: It's not elective, but you want all of these pieces going because they do create checks and balances. They do have different incidence, they have responsibilities. If all of a sudden like Congress checks out, there's a problem, if the President checks out, this is a problem, you know? So it's like you cannot expect the Fed to pick that up, that it's just, in talking about fundamental structural problems, that is a big one and that goes way beyond the economy. So, but hopefully this will be a wake up call on a lot of dimensions.

Beckworth: Right. And that is a silver lining here. I think there will be innovations, there will be reconsiderations of what we do and hopefully in a productive direction. I mean there might be innovations from everything from like drone deliveries actually working and getting us goods when we're stuck at home to maybe driverless cars going online, to maybe better governance and maybe we will see some changes. It's one thing to talk the talk, but when it comes time to actually implement change in policies, we need a slap in the face, a shock. And this might be it.

Sahm: We're going to wake up.

Beckworth’s Policy Proposal

Beckworth: One way or the other. One way or the other. Well let me throw at you my proposal. Okay? So my proposal is much more Fed centric and it does get at both a rules based approach, but it also says, look, we are going to be at this point, maybe we are already at this point where the Fed is going to be largely ineffective. And I don't like to use that term but it's going to need more tools in its tool box, put it that way. And so my proposal is kind of a threefold proposal.

Beckworth: Number one, the Fed needs to have a dual reaction function or two rules that it follows. And if it does this, it has to be much more explicit. It has to actually write them down, put it in its statement at the beginning of the year that it does every year. And the first rule says when interest rates are above 0% you follow something like a Taylor rule. So you write down your favorite Taylor rule, put it in there. When the interest rates get to zero or below, you follow the McCallum rule. And this is named after economist Bennett McCallum. And for listeners who may not know, the McCallum rule actually for a while had a running along with the Taylor rule, but eventually the Taylor rule left that in the dust.

Beckworth: But the McCallum rule basically is a rule that tells you how to adjust the monetary base given some nominal GDP target or you could pick any target. But the McCallum rule specifically says nominal GDP. And so once you get to zero and assuming the Fed doesn't want to go negative or can't go very far negative, the only option it has left is just to adjust the monetary base. Well, how do you do it? Do it in a rules based fashion such that you're trying to hit some kind of target. And my third, well that's my first part.

Beckworth: My second part is you use a nominal GDP target, which is implied by this rule. My third part though is to give the Fed via changes in its law, a standing fiscal facility that can only be used once you hit zero. So when the McCallum rule kicks in, it does it with the fiscal facility, such that it sends checks directly to households. So, it's rules-based, it's trying to hit some kind of nominal GDP level target and it's sending funds directly to households.

Beckworth: And if there is a recovery and we get positive rates, we flip back into a normal kind of regime of a Taylor rule. So that may be a little too complicated, but that's kind of the direction I would like to see the Fed go. That would require, of course an act of Congress. And of course the devil's in the details. Well, what kind of indicator, could you really use nominal GDP and maybe not, maybe you use a monthly measure? We talked about this before when you're on the show, maybe use some big data measure of spending, household income, some kind of indicator that tells us whether households are doing well or not. Now you mentioned the unemployment rate, but some kind of measure of household dollar income would be my preference. But I'd love to hear your thoughts on that.

Sahm: I haven't thought a lot about the McCallum rule, like the more details of your proposal, I do completely affirm the idea that we're moving into a toolbox that we haven't used before. And we really need to think about that. I had various conversations and brainstorming about the Fed giving money directly to people, right? So this money financed fiscal policy or you call it helicopter drops, whatever you want to call it. And there is a real discussion about what can the Fed legally do right now? What would Congress have to change to open that up? How would they want to? There are a lot of details once you get into a space we've never done before. But that's… frankly, we should be doing that when we are not in a crisis. A crisis is not a good time to dot all the I's and cross the T’s, you did not have time.

Sahm: You have to act. And when you act fast, you're going to make mistakes. So, I think we should be thinking. I don't know that I'd want to see, and I talked about why I don't really want to see the Fed sending out money right away. I do think, well, I think they're going to have to have framework review 2.0 next summer, and that's a discussion where this is just laid bare that there are much bigger issues than the interest rate transmission mechanism is weaker than it was 10 years ago. So I like that. I think that's a kind of big and bold thinking that we have to have, but that's a big discussion.

Beckworth: Well, with that, our time is up. Our guest today has been Claudia Sahm. Claudia, thank you again for coming on the show and come on back when things have gotten better.

Sahm:  Sounds good. Thanks so much. I appreciate it.

Photo by Alastair Pike

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