Uncertainty will exacerbate economic impact of virus - Fed paper

(Reuters) - The spike in uncertainty that has accompanied the spread of the coronavirus and efforts to contain it will likely contribute to a surge in U.S. unemployment and a decline in inflation, researchers at the San Francisco Federal Reserve said on Monday.

In addition to causing sickness and death, the virus has weighed heavily on the economy as business activity is curtailed and people practice social distancing. The economic effects have been exacerbated by uncertainty over the path of the virus, and how long the economy will be shut.

Historically, "periods of heightened uncertainty are followed by persistent increases in the unemployment rate and protracted declines in inflation, despite declines in interest rates," San Francisco Fed research chief Sylvain Leduc and economist Zheng Liu said in the regional Fed bank's latest Economic Letter. "By raising uncertainty, the coronavirus affects the economy in a way similar to a decline in aggregate demand."

The Cboe Volatility Index <.VIX>, a measure of fear and uncertainty in financial markets, hit a record closing high earlier this month and is still well above its normal levels.

That elevated uncertainty alone - due in part to the lack of clarity on how soon and how well the virus will be contained - could add 1 percentage point to the unemployment rate over the next 12 months, and subtract as much as 2 percentage points from inflation in the next six months, the researchers estimated.

The Fed had struggled to meet its 2% inflation target even when unemployment was near 50-year lows, persistently falling short of its goal.

The Fed's move earlier this month to reduce interest rates to near zero is expected to help cushion the impact of uncertainty on economic activity. But the virus is nonetheless expected to have a profound and protracted impact on economic activity, the researchers said.

(Reporting Ann Saphir; Editing by Andrea Ricci)