Allowing zombie companies to linger might be why long term growth suffers: Economist
BNY Mellon Asset Management Chief Economist Vincent Reinhart joins Yahoo Finance’s On The Move panel break down how markets are faring and the Fed’s latest response to the coronavirus crisis.
JULIE HYMAN: But let's talk more about the Federal Reserve and the patience that they seem to be exhibiting in terms of not raising rates anytime soon. We heard from Jay Powell yesterday.
JEROME POWELL: We're not thinking about raising rates. We're not even thinking about thinking about raising rates. So what we're thinking about is providing support for this economy. We do think this is going to take some time. I think most forecasters believe that.
JULIE HYMAN: Not even thinking about thinking about it. Brian Cheung was in that Zoom press conference yesterday. That's how they do it now. What stood out to you, Brian, from the commentary?
BRIAN CHEUNG: Julie, while the commentary that Jerome Powell really offered up was that, yes, there will be a recovery, it likely will begin in the second half of this year, but it won't be quick, and it won't be all that rapid. And I think that Jerome Powell was trying to toe a cautious line here and saying that the Federal Reserve is going to use its tools and act as appropriate to do whatever it can to support the economy here but that it won't be a very quick recovery here with more than 20 million workers displaced right now.
So again, the big headlines from that meeting yesterday, the Fed holding rates steady at the zero bound between 0 and 25 basis points and signaling that even though financial conditions have improved, they won't raise rates anytime through 2022. Only 2 of the 17 FOMC participants saw a case for raising rates before that period of time.
One other thing that was closely in view was any sort of commentary on yield-curve control. This is a widely talked-about concept where the Federal Reserve could pin down medium-term interest rates by buying three- or five-year Treasurys, for example, at a certain pace until they reach a certain yield target. The Federal Reserve and Jerome Powell yesterday saying that it's under consideration, that they'll be discussing it in an upcoming meeting. So no announcement yesterday but could be hinting at a possible new tool for, again, pinning those medium-term rates sometime in the future.
But someone that's very closely watching the Federal Reserve, in addition to obviously us, President Donald Trump this morning tweeting just about an hour ago, quote, "The Federal Reserve is wrong so often. I see the numbers also and do much better than they do. We will have a very good third quarter, a great fourth quarter, and one of our best ever years in 2021," end quote. Not exactly sure which forecast President Trump is referring to, but you can assume it had to do with that negative 6.5% GDP forecast from the Federal Reserve yesterday. Julie.
JULIE HYMAN: Yeah, the president sometimes a hawk, sometimes a dove. So not quite sure where that tweet [INAUDIBLE].
I want to bring in Vincent Reinhart to the discussion now. He is BNY Mellon Asset Management Chief Economist. He's joining us from St. Petersburg, Florida. Vince, it's good to see you. You came out with a note that while the Fed is talking about a protracted path to recovery here, they're not actually changing their GDP forecast, or they didn't yesterday, right, saying it's too early. Is there anything we can take away from that that perhaps there is a little cause for optimism or the opposite?
VINCENT REINHART: I think there's a couple things going on, and the observation is Jay Powell spent a lot of time over the last few weeks saying that a crisis has a long-lived effect on activity. You don't put in place capital. People leave the workplace and they don't come back. Businesses shut and don't reopen.
He spent a lot of time doing that, and then when they compiled the Summary of Economic Projections, there was really no change in the long-term real GDP growth or the long-term unemployment rate.
I think there's three parts to it. Number one, he is representing the committee. The Summary of Economic Projections is an aggregation. He goes out of his way to emphasize it's not a joint forecast. And he may have-- he probably has a lot of colleagues who aren't there yet. And, you know, if you look at the range, there were some low numbers. I bet he was in the lower one.
Number two, there's a limit to how much you want to talk down the economy, particularly the longer-term outlook. That's not probably a good idea for equity prices.
And number three, he was holding out this hope toward the end which is maybe we'll get that result if we get good policy. Hint, hint to the Congress and the president. Fiscal policy might prevent the bad outcomes I really worry about.
ADAM SHAPIRO: Hey, Vincent. It's Adam, and it's good to see you. So we hear Jay Powell, and we've heard Federal Reserve chairs in the past talk about they're not focused on the markets or the steps they take are not designed to boost the markets, but you've been on the inside. Do they really believe that? And when they have these discussions about the consequences of their actions, do they ever talk about the fact that, especially today, they're allowing zombie companies to live into the future that could cause more damage?
VINCENT REINHART: Yeah. By the way, allowing zombie companies to linger might be why long-term growth suffers as a consequence of a severe financial crisis and economic recession.
There's a couple things. By the way, Chair Powell said he's not thinking about thinking about raising rates. Technically if you're actively not thinking about something, you're thinking about it. It's like asking a preschooler don't think about an elephant. The elephant in the Fed's room is when would they ever raise rates? He's trying to tell you as much as possible it would almost be never.
Do they worry about-- the dirty secret in a central bank is central to the monetary-transmission mechanism is relative financial prices-- equity prices, the long-term sovereign yield, and the exchange rate. Two out of three are kind of unseemly to talk about. You don't want to be seen as supporting equity prices. You don't want to be seen as actively trying to depreciate your currency relative to your colleagues' central banks. But low rates lower the discount rate to future earnings and keep equity prices higher than they would be otherwise.
I think there's two parts to Powell's answer about is he inflating a bubble? The first part is, well, given the slowness of the discount rate, given the lowness of the policy rate they have set, equity prices don't look all that high relative to the Fed model evaluation. And part two, we intend to keep that discount rate, that policy rate low for a very long time. So it's not really a bubble. It is a sustained period of overpriced relative to the long-run fundamentals.
BRIAN CHEUNG: Hey, Vincent. It's Brian Cheung here. Those are all interesting points, and it seems like maybe one way that the Federal Reserve could get around that would be by offering market participants a little bit more certainty about what Fed policy is going to be, let's say, in the medium term. So if it's not yield-curve control, some sort of forward guidance where the Fed says we'll keep rates low until we hit x target on unemployment or on inflation.
Do you see that the Federal Reserve might do that in its July meeting or in its September meeting, and do you think that might be too late? Should the Fed have already done something yesterday?
VINCENT REINHART: Yeah, so actually I went back, and I did a briefing to the FOMC in 2003 where I said-- where I opened by saying the hardest thing for a policymaking committee is to do nothing. Policy is supposed to be forward looking. They base their policy on the outlook. To put it in Jay Powell's terms, the economy's in a bad place, but it's the place we expected it to be when we set policy. Therefore, the current setting of policy is in a good place. So they don't really-- that's why they didn't have to do anything.
The first line of defense for Jay Powell is communication. He has talked out tightening till 2023. That's what the Summary of Economic Projections that you characterized explains. Nobody expects them to raise rates anytime soon.
If it turns out that the economy comes back pretty strongly-- even though the level is low, the growth rate's very high, and markets start backing up and inappropriately expect policy firming. Then they could do something like a rate guidance, i.e. the Evans rule they had back in 2012 to 2014 that says we wouldn't-- we're not going to touch the funds rate as long as the unemployment rate is above 6 and 1/2% and inflation is not in our forecast going above 2 and 1/2%.
So they could do that, but they're going to be pressed by events. I would say yield-curve control is even further down the list because the thing we've seen about the Federal Reserve facilities is there is a slippery slope attached to them. The perimeter has expanded as they've brought in-- they've redefined and redefined who they help, and the maturity has extended as they've lengthened how long that help will be.
If they get into the business of fixing Treasury yields, it's going to be hard to get out of it. And the perfect example is the Fed was there before. The Treasury gave it instructions to put caps on yields in the 1940s to support the war effort. It didn't end until 1951. They waited until even a second war. That is interventions last past their shelf life.
BRIAN CHEUNG: Vincent, I want to ask really quickly-- I mean, all of that is really interesting within the framework of the Fed review, but I think a lot of people are also fixated on the wealth inequality bit that Chairman Powell was fielding a few questions on yesterday. Very timely given the nature of the news cycle right now.
I'm wondering-- Chairman Powell saying that monetary policy is really not the main driver of income inequality. I thought that was an interesting comment. What do you think about that?
VINCENT REINHART: It's partly true. Look, you have to give Chair Powell credit. He has been out front. He followed in the steps of Chair Yellen who had brought that into the attention, the radar screen of policymaking, and it's part of the discussion. It's not going away. And he's really continued that, and he really was very empathetic.
The big picture-- inequality is about the structure of the macro economy. Federal Reserve policy doesn't do much about that.
However, there's a cyclical element. Bad economies hit lower-income households harder if there's just a straight principle of last in, first out in the employment market. So as much credit as they were taking for the very low level of African American and Hispanic unemployment rates six months ago, they look terrible now.
The second part of it is back to the monetary-transmission mechanism. It goes through markets. It is inflating equity prices, and equity prices are the value of something that is held unequally. Wealth is concentrated in-- very concentrated in the US, concentrated in high-income families. So when the Federal Reserve boosts markets, it is an unequal act.
JULIE HYMAN: Vincent, thank you for all of your perspective on that, not just the meeting yesterday but income inequality. Vincent Reinhart is the BNY Mellon Asset Management chief economist. Thank you very much, Vincent. Appreciate it.
VINCENT REINHART: Thanks for having me.