Scott Sumner:

To be sure, the Fed cannot work miracles. It may be impossible to achieve its targets over the next few months, especially if a significant part of the economy shuts down due to coronavirus fears. What the Fed can do is ensure that expectations for next year’s economy remain on track.

To this end, the Fed should do enough monetary stimulus so that market forecasts predict roughly on-target growth and inflation in 2021. Bullish expectations for next year – hope on the horizon – can reduce the severity of any near-term decline in output that might occur due to a fall in spending.

Unfortunately, right now it looks like the markets are not just expecting a weak 2020, but also a weak 2021 and 2022. If the economy were expected to bounce back in six months or a year, the yield on 10-year bonds would not have fallen to 0.5 percent and the yield on 30-year bonds would not have fallen to 1 percent. These unusually low yields, as well as plunging stock prices, reflect market expectations of weak spending for years to come. If the market is correct, then there is a risk of much-higher unemployment, just as bearish market forecasts in late 2008 ultimately were borne out by much-higher unemployment over the next few years.