The Fed's big guns are welcome, but the United States needs more fiscal action
The Federal Reserve’s move on March 15 to drop the federal funds rate another percentage point to essentially zero, along with other steps to support credit markets and the economy, represents a substantial and appropriate easing of monetary policy at a time of health crisis. The announcement at an unusual weekend conference call underscored the urgency of the situation. But no amount of monetary easing can prevent a sharp decline in economic activity in the near term owing to measures taken to slow the spread of the novel coronavirus.
As Fed Chair Jerome Powell mentioned several times during the press conference after the March 15 meeting, fiscal policy is needed to help those most affected by the ongoing slowdown. As welcome as the latest Fed actions are, they will not by themselves undo the expected sharp drop in consumer spending as large swaths of the economy go into suspended animation over the coming weeks and perhaps months.
The Congress and the president need to take rapid fiscal action to help those who have lost jobs and sales and to stave off a wave of debilitating bankruptcies. Because speed is of the essence, just mailing out checks to everyone is probably the best practical option for now. An additional option that would take more time but may be worth considering is for the federal government to provide aid (or step in as an emergency “customer”) to specific firms and households that are most severely hurt by the temporary collapse in spending. The Fed does not have the power to provide cash transfers on either a broad or a targeted basis.
Here are the Fed’s important actions in the first half of March 2020:
- On March 3 the Fed lowered the target range for the federal funds rate to 1.0 to 1.25 percent.
- On March 12 the Fed announced it would offer financial institutions the opportunity to borrow against their holdings of government securities for terms of up to three months (term repo) in practically unlimited amounts (up to $1 trillion per week through the end of March at least).
- On March 15 the Fed lowered the target range for the funds rate to 0.0 to 0.25 percent. It lowered the rate of interest it pays on bank reserves to 0.1 percent and the rate offered on overnight reverse repurchase agreements to 0.0 percent. The rate of interest on reserves is now lower than it was during the Great Recession of 2008–09.
- The Fed announced it would resume large-scale purchases of Treasury securities (at least $500 billion) and agency mortgage-backed securities (at least $200 billion), in other words quantitative easing (QE). Note that total QE purchases during 2008–14 exceeded $3 trillion.
- The Fed also reduced the spread of the interest rate on bank borrowing at the discount window from 0.5 percentage point over the top of the funds rate range to 0 percentage point. These are loans secured by a broader range of collateral than is accepted in the repo market. The lower spread over the funds rate is important because it reduces the stigma that discourages banks from accessing the window (because paying a higher rate makes them seem desperate).
- The Fed encouraged banks to use intraday credit as needed for smooth operation of the payments system.
- The Fed encouraged banks to use their substantial capital and liquidity buffers as needed to support households and businesses affected by COVID-19. (They may have had some success in this regard because the eight largest banks issued a joint statement saying they will suspend share repurchases in order to preserve capital for lending.)
- The Fed abolished reserve requirements for banks, which may help some smaller banks but had little impact on most major banks because they already hold far more reserves than they are required to hold.
- The Fed reduced the interest spread and increased the maximum term of swap lines that provide secured dollar credit to several foreign central banks to help them in providing access to dollar-based funding in their local markets.
- On March 16 the Fed and other bank supervisors issued a statement encouraging banks to use the Fed’s discount window.
If this looks like a lot, it is. But given the unique nature of this slowdown, it is not clear how much additional monetary ease might help. Lower interest rates will have little effect on the immediate drop in spending associated with social distancing measures, and spending may rebound quickly after these restrictions are removed.
Perhaps the more important steps are those that calm financial markets and encourage banks to step up their lending to affected households and firms. Additional actions on this front might include lending to banks that expand their loan books during the slowdown at a subsidized rate or setting up an emergency loan facility for broad categories of nonfinancial firms as authorized by Section 13(3) of the Federal Reserve Act.
The Fed could take further monetary policy steps if the shock to spending appears likely to last more than a few months. The Fed could reduce the funds rate below zero, as central banks have done in Europe and Japan. It could expand its QE purchases, especially in mortgage-backed securities to bring down mortgage rates and enable households to refinance on exceptionally good terms.
In his press conference on March 15, Chair Powell said that he and his colleagues “do not see negative rates as a likely policy response here in the United States.” As Chris Collins and I discuss in a recent PIIE Policy Brief, setting the funds rate slightly below zero, perhaps to –0.5 percent, would help more than might appear at first glance because it also opens up more scope for QE to reduce bond yields. But negative rates are politically controversial and would not likely be a game changer for the economic slowdown that is expected over the next few months.