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Fixing ailing economy

The precise state of the U.S. economy is elusive, especially since the onset of the COVID-19 pandemic. Some analysts see a flourishing economy while others see impending failure. Either view could turn out to be correct. But the Federal Reserve, tasked with ensuring a stable economy, has employed every instrument in its monetary armament to see that a healthy, growing economy prevails. The variation of opinions about the state of the U.S. economy stems, in large part, from the chasm between the record-setting highs of the stock market and less-than-encouraging indicators of economic well-being. How can the disconnect between the record-setting stock market values be reconciled with what, otherwise, seems to be an ailing economy? The answer is that stock market values are now impacted more by investor sentiment and hope than by the underlying value of the corporations that comprise the stock markets. One way to demonstrate the disconnect between stock markets and the real economy is to compare trends in the common indicators of economic well-being to trends in stock market values. A favored economic indicator among economists is Gross Domestic Product (GDP), which fell 31.7 percent in the second quarter of 2020. Since the second quarter, GDP has recovered significantly, but still lags its pre-COVID-19 levels. Unemployment hit a high of 14.7 percent in April 2020 but gradually improved to 8.4 percent in August 2020. However, the unemployment rate is still more than twice the rate of August 2019. These statistics indicate a recovering, but not a fully recovered economy, and certainly not an economy that justifies the stock markets’ record highs. What force has enabled the stock markets to excel in the face of discouraging economic data? The answer is the Federal Reserve. The Federal Reserve is tasked with ensuring a stable U.S. monetary and financial system, which it accomplishes through its application of monetary policy. Even before COVID-19, the Federal Reserve aggressively worked to stabilize the economy, which had already shown signs of weakness. The Federal Reserve implemented many of the tools it has used in the past: lowering interest rates to increase liquidity and trigger economic growth; providing forward guidance to put downward pressure on longer-term interest rates; and quantitative easing, which involves the purchase of government bonds and securities to increase the money supply and encourage lending and investment. It is debatable how successful the Federal Reserve has been in stabilizing the economy, but the Federal Reserve has clearly instilled sufficient confidence in investors to drive the recent market rallies. It is primarily investors’ faith in the Federal Reserve’s commitment to support the economy that drives the market rallies. However, if the underlying problem – the COVID-19 pandemic – persists long term, the Federal Reserve will not have the tools to maintain investor confidence and sustain the recovery. Then, as the markets and economy realign, which they inevitably will do, investors will find that their exuberant confidence is no match for the reality of an ailing economy.

Dr. Martin Blank Saginaw

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