The economy is in free fall.
About 22 million people — or more than 13 percent of the US labor force — have filed for unemployment in the past four weeks. Economists are projecting unemployment as high as 20 percent within a matter of months. Entire industries, like hotels and airlines, have all but shut down, and the rest of the economy is slowing as people stay indoors and the panic from the coronavirus shock turns into an ongoing recession.
When the economy is collapsing like this, there’s an actor who is supposed to step in: the Federal Reserve.
While Congress occasionally steps in to offer stimulus through tax and spending programs (and it has, though it can do much more), the primary duty of preventing and mitigating recessions in the US rests with the Federal Reserve, which is obligated under federal law to minimize unemployment.
The Fed hasn’t always lived up to that mandate. Despite taking extreme, at times heroic measures to rescue the economy in 2008-’09, the Fed still oversaw a prolonged, painfully slow recovery that took a decade or more to reach full employment again. It continually undershot its inflation target, even as people were suffering from mass joblessness.
To its considerable credit, today’s Fed has been taking aggressive steps to fulfill its mandate, even bigger steps than the financial crisis-era Fed did. Fed Chair Jay Powell has committed trillions of dollars of Fed purchases to combating the coronavirus downturn and making sure businesses have easy access to credit. He has brought interest rates down to zero and taken the unprecedented step of subsidizing state and local governments by buying their bonds.
But while it’s become common to argue that the Fed is “out of bullets” since it’s done so much, nothing could be further from the truth. There’s still more the Fed can and should do to end this recession. Here’s what it has done so far, and what work it can still do to ease the suffering of millions of Americans.
The Fed’s actions to date, summarized
Cut rates to zero
On March 15, the Fed announced that it would cut its target interest rate to a range of 0 to 0.25 percent, returning rates to the record lows they reached during the 2008-’09 recession and its aftermath.
The Fed funds rate (often colloquially called the “Fed rate” or even just the “interest rate,” given its economy-wide effects) is the primary mechanism through which the Fed influences the American economy. When the Fed uses its powers to lower the rate, that means borrowing is cheaper: Mortgage rates fall, APRs for credit cards fall, auto loans get cheaper, etc. This is meant to stimulate economic activity by making it cheaper for businesses and consumers to borrow and spend.
The Fed enforces this target both through expectations (it’s powerful enough that just saying “we’re lowering rates” causes banks and other actors to follow suit) and through “open market operations,” in which it buys up Treasury bonds with money it creates in a bid to make those bonds’ interest rates fall to its target range. (For more, see Matt Yglesias’s explainer.)
The March 15 action was actually the second move the Fed made on interest rates in response to coronavirus. On March 3, the board slashed rates from a 1.5 to 1.75 percent range to 1 to 1.25 percent, a half-point cut. Now that rates are down to 0 to 0.25 percent, there’s nowhere left to go except negative. The Fed hasn’t done that before, but it could; see more below.
Unlimited quantitative easing
The Fed hit the zero lower bound pretty quickly in the financial crisis of 2008-’09. Once it did, it moved from trying to manipulate short-run interest rates (like the federal funds rate) to long-run interest rates, like the interest paid on 10-year US Treasury bonds. Normally it does this through “quantitative easing” — just buying up massive quantities of bonds, in particular US government bonds and mortgage bonds from Fannie and Freddie. Historically the Fed has committed to buying a specific amount of bonds, either one time or every month or quarter. Its coronavirus response started that way, with $500 billion in government bond buys and $200 billion of mortgage bond buys.
Then on March 23, it announced that quantitative easing would be unlimited. The Fed declared that it would “purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” It also expanded what bonds it bought to include commercial real estate, not just home mortgages.
This was a major escalation from previous QE efforts because it assured markets that the Fed would keep acting indefinitely to keep long-term rates low. Uncertainty about whether QE will abruptly end, or fall short of what’s necessary, could harm the recovery, so the Fed tried to eliminate that uncertainty entirely.
Skeptics of QE argue that it hurts savers (like pension firms) at the expense of people with debts. That’s part of the point, to help people get out from under debt incurred during the recession and to encourage people and businesses to take out more debt. But it provoked some political backlash.
Buying up corporate bonds
The same day that the Fed announced unlimited QE, it also announced the creation of a variety of programs to buy up bonds not covered by the QE program. Those include new and old corporate bonds and bonds backed by consumer debt other than mortgages (student loans, auto loans, credit card loans). It also announced it would set up a “Main Street Business Lending Program” to facilitate lending to small businesses.
These programs ensure that interest rates on these kinds of loans to individuals and businesses don’t get too high and that there’s a market to buy them. That way, banks have an incentive to keep issuing loans, knowing the Fed at least could buy them.
“Traditional logic would say that actions in the corporate bond market (which is tapped by bigger businesses) should trickle down to small businesses and consumer credit,” Yglesias explained when these moves were announced. “But today’s Fed isn’t taking chances. … All kinds of loans — federal government debt, consumer debt, corporate debt, mortgage debt, commercial real estate debt, and small business debt — are going to get help.”
Later, on April 9, the Fed announced various moves to strengthen these efforts to buy up different types of debt. It offered new loans to small businesses participating in the Paycheck Protection Program, committed to buying as much as $600 billion in loans from small businesses, and expanded the size or scope of the corporate and consumer bond purchase facilities. It also …
Buying state and local bonds
… set up a $500 billion fund to buy bonds from state governments and a few large local ones, which are seeing tax revenues collapse and are much more constrained than the federal government when it comes to spending. Buying up the bonds cheap helps stabilize the municipal bond market and makes it more affordable for states and cities to take out loans now to cover pandemic expenses.
In total, the April 9 actions added $2.3 trillion to the Fed’s purchasing efforts.
Options still on the table
Negative interest rates
The Fed has set interest rates at a range of 0 to 0.25 percent. This means it’s hit the “zero lower bound” — it can’t cut interest rates any further without going negative.
That said, it can go negative. The European Central Bank has been experimenting with modestly negative interest rates since June 2014, and the Bank of Japan has since January 2016. The Fed has never done the same, but these are not normal times.
Under a negative rate system, investors have to actually pay borrowers to take their money — that is, it would actually cost you to put money in the bank. The idea is that this would push you to spend your money instead of parking it in your account.
The ECB rate is only -0.5 percent, a very small cost to most depositors. But if rates get too negative, there’s a risk that businesses and individuals will start pulling their money from banks entirely and holding cash; if your checking account is losing, say, 5 percent of its value a year, there’s a good case for taking your money out and stuffing it under a mattress.
There are ways to get around that, though. Harvard economist Greg Mankiw has suggested that the Fed could declare all paper money with a serial number ending in “0” invalid, effective a year from now. That sets up an effective rate of negative 10 percent, so if the Fed sets a rate of, say, negative 6 percent on money still in the bank, that’s still an incredibly appealing proposition compared to getting a tenth of your cash wiped out.
Miles Kimball at the University of Colorado has proposed a similar system wherein the Fed would set up an “exchange rate” between paper and electronic money, so that when you deposit $100 in cash, less than $100 is added to your bank balance. That would similarly enable negative rates and limit the incentive to hoard cash, since it can’t be deposited and used to pay checks, credit card bills, etc., and most people have bills they can’t pay in cash.
Explicitly set government bond rates
One idea publicly floated by now-Deputy Fed Chair Richard Clarida would be to take quantitative easing a step further and commit to buying up US government bonds until rates on long-term (10- and 30-year) bonds hit an explicit target — say, 0 percent.
This would have several benefits. One, it would provide some focus for the Fed’s commitment to unlimited quantitative easing by making it clear what the goal of that measure is. The Fed is clear that it wants to lower long-term interest rates, but not what it wants to lower them to, and clarifying that in terms of government bonds could give quantitative easing more power and make it more effective in lowering those rates and making it cheaper for individuals and businesses to take out long-term loans.
Second, it would help Congress in developing their own response. Mandating that government bond rates are 0 or negative in inflation-adjusted terms would give Congress a guarantee that it can cut taxes and boost spending as much as necessary to fight the downturn, without risking runaway debt; it would be free or cheaper than free to borrow.
Target levels, not rates
Currently the Fed targets a given rate of inflation — 2 percent per year, for instance. What it tries to communicate to markets is that if inflation goes above that rate, it will take action to contain it, and conversely that if inflation falls below that rate, it will take action to increase it.
The problem has been that the Fed’s obedience to this target has been asymmetrical. Inflation has undershot the Fed’s target for well over a decade now:
The Fed not only hasn’t been able to get it much higher but also hasn’t tried to get prices of goods and services to where they would have been if the US had had steady 2 percent inflation every year from, say, 2008 to present.
Many economists have called for the Fed, in response to this failure, to adopt “level targeting” — not simply trying to hit a given rate of inflation, but trying to get consumer prices to where they ought to have been if inflation had hit the Fed’s target every single year. That means committing to aggressive action, and several years of above-trend inflation (say, 4 or 5 percent annually), to get back on track.
This suggestion is often paired with a proposal to move from targeting inflation to targeting nominal GDP — the size of the economy, not adjusting for inflation. The hope is that NGDP reflects both the rate of inflation and the underlying state of the economy, and targeting it could force the Fed to be more aggressive when economic growth is lagging and unemployment is rising. The Fed has a statutory duty to minimize both unemployment and inflation, and NGDP offers one way to do that.
Let low-income countries print dollars
One of the Fed’s less recognized policy tools is “swap lines”: defined arrangements that let other countries trade their currencies for dollars. The idea is that the dollar is a stable global reserve currency, whereas other countries’ currencies tend to be less stable, creating risk around exchange rates that can deter investment, especially in developing countries. Expanding access to credit in dollars can thus help safeguard other countries’ economies.
The Fed has long had these in operation with rich countries like the UK, Canada, and those represented by the European Central Bank, but recently expanded them to include a few emerging markets like Mexico and Brazil. Expanding to even more developing countries could help them recover.
Helicopter money, or printing money and giving it to people
Perhaps the most straightforward way for the Fed to help the economy would be to put money directly in people’s hands by printing it and mailing out checks.
It’s doubtful the Fed can do this under current statutory authority, but some in Congress have argued for giving it that authority. House Financial Services Committee Chair Maxine Waters (D-CA) has proposed $2,000-per-month checks to adults and $1,000-per-month checks to children funded by printing money. A simpler idea would be to simply let the Fed send out checks the same way that Congress did through its recent $1,200 check initiative.
Helicopter drops have a long and distinguished history as a monetary policy idea; Ben Bernanke, for instance, has argued they have a place in the policy toolkit. The Fed has traditionally shied away because it views giving money to people as the domain of fiscal policy and thus of Congress. Congress could remove that hesitation by explicitly authorizing the Fed to drop helicopter money. The Bank of England is already doing something like this by directly funding government operations via printing money, so the Fed would be in good company.
Buy corporate stocks
The Fed has supported corporations by backstopping the corporate bond market and ensuring that short- and long-term interest rates remain low. But there are other actions it could take as well, though they would potentially require authorization from Congress.
The most straightforward option would be to buy corporate stocks, the way the Bank of Japan has done in recent years. That not only helps stabilize the stock market directly, it enables the Fed to set up a sovereign wealth fund invested in the US economy whose profits it can refund to the Treasury. That effectively provides a way to finance federal spending besides taxes and debt, which can be helpful if we need more fiscal stimulus in the future.
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