What does the Federal Reserve hope to achieve with its response to the crisis?
The Fed has three primary goals.
First, to support the markets that allow banks to function. The banking system would not work without these short-term funding markets, as banks rely on them, in addition to their deposit base, to make loans. These markets are thus critical to making sure that the financial system doesn’t amplify the enormous shock from the coronavirus.
Second, to make sure the market for U.S. Treasury bonds is working smoothly. U.S. treasuries provide the collateral that backs a lot of the transactions that are central to today’s financial system. But it is also clear that the U.S. government will need to borrow the funds necessary to limit the virus’s economic fallout and to slow its spread. The Fed wants to make it very easy and very cheap for the U.S. government to do so.
Finally, the Fed wants to make sure that the banks of some of America’s biggest foreign trading partners also have access to emergency dollar financing. This basically means lending the European Central Bank (ECB), the Bank of Japan, the Bank of England, the Bank of Canada, and the Swiss National Bank the dollars they need to lend to their own financial institutions. The dollar isn’t just used in the United States, it underpins a lot of global trade and finance.
What specific measures has the Fed implemented?
To accomplish these goals, the Fed lowered interest rates to near zero. This was critical, as a lot of institutions will need to borrow over the next few months. Perhaps even more importantly, it indicated it would buy at least $700 billion worth of Treasury bonds and agency-backed mortgages—the final amount may end up being bigger—and made it easier for U.S. banks to borrow directly from the Fed. It is also using its emergency authority to set up a vehicle for lending directly to businesses, in the commercial paper market, for the first time since 2008.
Additionally, it signaled that it would now allow banks to use the capital and liquidity buffers built up over the last ten years to support higher lending.
And finally, the Fed agreed to lower the interest rate on its existing swap lines, which provide dollars to many (though not all) of America’s key trading partners, allowing foreign central banks to borrow dollars from the Fed and lend them to their own banks. This will provide banks outside the United States with access to longer-term financing.
What is the state of international cooperation between central banks or other financial institutions?
Central bank cooperation remains quite strong, and the major central banks are in close contact. The best evidence of that is the swap lines. The Fed will likely need to allow more countries’ central banks access to the swap lines soon, allowing some of the smaller central banks from credit-worthy countries to borrow dollars in this way too.
All the major central banks have now lowered their interest rates to zero (or below) and both the Fed and the ECB have stepped up the pace of their asset purchases. The response to date has been both cooperative and broadly consistent, though the Fed now is acting somewhat more aggressively than the ECB.
How does the crisis compare with 2008 from a monetary policy perspective?
The main difference with 2008 is that this crisis didn’t originate from within the U.S. financial system; it was an unexpected, outside shock. That makes concerns about rewarding banks for their past bad behavior less central than it was in 2008. The other critical difference is that most central banks entered this crisis with much less ability to support the economy just by cutting short-term interest rates than was the case back in 2008. As a result, they have been much faster to turn to other policy tools.
How much will these moves help businesses in the non-finance sector—airlines, automakers, or smaller companies—that have large amounts of corporate debt?
Lower interest rates on new borrowing always help, but they aren’t sufficient. A lot of companies will need significant amounts of cheap credit from the banking system to tide themselves over. That is why the steps the Fed took to provide banks access to new financing are important—the balance sheet of some banks will need to grow, as they help tide major companies over.
Of course, no amount of financing can make up for a lack of customers. The government will ultimately need to provide direct help to some key firms. The real question isn’t whether the airlines will get help, but rather on what terms. Creditors of big and small firms alike will need to exercise a lot of forbearance; aggressively trying to collect on past debts while we are all adapting to the requirements for limiting the spread of the virus isn’t going to be productive.
What other tools does the Fed have left?
The Fed has consistently said that it doesn’t want to adopt negative interest rates, as other central banks have done. But that doesn’t mean that the Fed lacks tools.
One relatively straightforward option is to indicate that it will keep rates low for a long period of time— so-called forward guidance. Another is to buy longer-term government bonds (large-scale asset purchases, also called quantitative easing, or QE) to keep the interest rate on these bonds down even as the government borrows more. It can also indicate that it isn’t just targeting short-term interest rates, but also long-term ones. For example, it could bring the interest rate on ten-year treasuries down to zero.
Additionally, the Fed has broad emergency powers—its so-called 13-3 authority. That authority will likely need to be used creatively, as it has been in providing liquidity to the commercial paper market. There is now talk of easing some of the restrictions that the Dodd-Frank financial regulations placed on the Fed’s use of this emergency authority, which is sensible. If the Fed’s emergency authority is combined with Treasury resources—as it was during the 2008 crisis—the Fed would have even more legal room to maneuver.
Creativity from the Fed is not enough. It needs to be matched by broad-based policies that assure everyone, even those who now cannot work, a basic income, as well as a lot of cooperation from creditors who must realize that they have no scope to collect on their outstanding debts until after the medical fight against the virus has succeeded.