For 2019, the Fed’s “severely adverse scenario” posited a growth rate of minus-5 percent in the first quarter, followed by more negative growth through the year; unemployment spiked to 10 percent; stocks fell 50 percent; and the VIX market volatility index peaked at 70. Ten-year Treasury yields bottomed out at 0.8 percent as severe recessions swept Europe, the United Kingdom and Japan.
The good news is that the banks passed, proving once again that the stress test requirement has rendered them safer, and that this particular provision of Dodd-Frank is one of the wisest laws Congress has ever passed.
The bad news: Even when the Fed tried to imagine the worst, it could not quite imagine the sudden stop to the global economy that is taking place now.
Already, some economic indicators — actual and projected — meet or exceed parameters of the severely adverse scenario outlined in the Fed’s 2020 stress test, published in February.
The VIX has hit 70, which was not quite projected to happen until the quarter ending in June, and the Dow Jones industrial average is below the Fed’s assumed 22,262-point first-quarter level. Plausible forecasts for second-quarter growth are in the negative double-digits, as opposed to the minus-9.9 percent in the Fed scenario.
In short, the hypothetical stress test is now all too real. The banks are holding on, with considerable help, direct and indirect, from the Federal Reserve. What remains unclear is whether these pillars of the global economy can withstand what might lie ahead.
The Fed stress tests were designed for a world in which recessions, even a sharp, prolonged one lasting 21 months — as in the 2020 stress test scenario — result from cyclical factors, and that robust growth resumes when downturns end, with unemployment falling to manageable levels.
The situation now, however, stems not from a catastrophic failure in the economy, which was actually in good shape as of early March, but from a sudden series of political decisions, which, taken together, essentially halt great swaths of production and consumption on the grounds of public health — indefinitely.
The World War II analogy applies to the sweeping nature of the national challenge; but totally unlike what happened in 1941, the national strategy, at least initially, hinges on deactivating fully utilized productive resources rather than activating idle ones (which abounded due to the Depression).
“Stimulus” is a bit of a misnomer for government’s role in this utterly novel and perilous situation. The Treasury Department can write consumers all the checks it wants, but that doesn’t help when people can’t even go out for a smoothie.
“Survival” would be a more honest descriptor. Massive government-backed lending may buy time for public-health measures to work, thus achieving our national goals without widespread household bankruptcy and the destruction of capital — physical, human and financial — that might otherwise impoverish the country for years.
All of that is fancy language for: chronic mass joblessness, permanently shuttered factories and stores, less-educated kids and all the anxious humiliation that comes with daily life on the edge of survival.
There is a rational basis for hope: History shows that communities can absorb horrific shocks and recover, from the German postwar “economic miracle” to New Orleans’s rebound from Hurricane Katrina, or, indeed, the U.S. comeback from the Great Recession of 2008. A strong “V-shaped” recovery is still thinkable.
The sooner we can start, the better. Resolving the coronavirus threat to public health is the necessary precondition. Yet just as we shut down economically on the basis of unavoidably imperfect information about the threat, we will probably lack clear, agreed-upon criteria for when it’s safe to blow the all-clear.
Federal Reserve Bank of St. Louis President and CEO James Bullard suggests designating now through July 1 as “National Pandemic Adjustment Period” (shorter or longer as virus control may require) to give firms and households more ability to plan — and confidence the emergency is not infinite.
It may also help to recall that, before the coronavirus, the hot topic in public health was “deaths of despair,” a phrase popularized by economists Anne Case and Angus Deaton.
As they argue in a new book with that title, a rise in deaths linked to long-term economic hardship — suicide, overdoses and the like — has caused devastation in communities across the middle of the country, leading to a troubling recent decline in U.S. life expectancy.
Economic prosperity is a matter of public health, too — the necessary condition for it, in fact. The United States must respond to the coronavirus accordingly.