Federal Reserve Vice Chairman Richard Clarida says the central bank has the tools needed to keep the U.S. out of a deflationary trap, even as the coronavirus deals a severe hit to the economy.

“Demand is impacted very adversely, we’re trying to offset that with our policy,” Clarida said in an interview on Bloomberg Television with Tom Keene and Michael McKee. “I believe it’s dis-inflationary. I don’t believe it’s deflationary. I think we have the tools to keep the economy out of deflation and to support the economy through this challenging period.”

The central bank has responded aggressively to blunt the effect of the pandemic on the U.S. economy, launching an unprecedented range of emergency programs to support as much as $2.3 trillion in loans and slashing interest rates to nearly zero. Still, the pain is already severe. Almost 17 million people have filed for unemployment benefits in the last three weeks, with output in the second quarter expected to shrink sharply.

Forcefully and Aggressively
“We’ll use our authority forcefully and aggressively until we’re confident the economy’s recovered,” Clarida said. “There is nothing fundamentally wrong with the U.S. economy. It came into the year in a very strong position in terms of employment and growth and financial markets and I’m confident we can get back there.”

U.S. inflation slowed in March, rising 1.5% annually as damped demand from the coronavirus pushed down fuel and other costs. Economists worry that a significantly heavy hit to the economy could depress demand so much that prices decline persistently across the board, encouraging consumers to hold off from making purchases -- in the hope that they will fall further. The Fed’s aggressive action is designed to stop the U.S. slipping into this so-called deflationary trap.

“We’re going to keep rates where they are, which is basically very close to zero, until the economy is on track to achieve maximum employment and price stability,” Clarida said. “We’re building a bridge until the economy can get to the other side and begin to recover and if that happens sooner we’ll certainly know what to do at that time.”

As part of its emergency programs, the Fed will fund the purchases of some types of high-yield bonds issued by companies that were rated investment grade before the start of the crisis, but have since been downgraded. Clarida defended the unprecedented move.

“Several important companies in the U.S. were investment grade up until this crisis hit,” he said. “And what we said in our programs if they’ve been downgraded after the date of the crisis they will have access to these new facilities.”

Moral Hazard
He also played down the threat of moral hazard -- of the Fed encouraging risky behavior in the market by providing support that shields investors from loss.

“I think moral hazard in past circumstances, when its been associated with financial excesses or private sector excesses, is obviously something to assess and think about, but in this case this is an entirely exogenous event,” Clarida said. “Businesses aren’t closing and people aren’t unemployed due to any fault of their own. And I think this is a clear as possible case that those aren’t relevant considerations.”

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