During the current Coronavirus environment, how Federal Reserve will use the Monetary policy which could contribute...

During the current Coronavirus environment, how Federal Reserve will use the Monetary policy which could contribute to Easy money supply/policy?

Expert Solution

The Fed reacted quickly and drastically to prevent the U.S. economy from falling down into depression. Monetary policymakers reduced the fed index to near zero; promised to more than double the size of the Fed's balance sheet by buying large-scale reserves of Treasuries and mortgage-backed securities with a view to reducing longer-run interest rates; and restarted or produced a range of special-purpose vehicles (SPVs) off the Fed's balance sheet to stabilize the Fed's balance sheet.

The Fed's decision to set up SPVs to buy corporate and municipal debt opens the door to mischief of all kinds. Likewise, more volatile assets are now recognized by the Term Asset-Backed Securities Loan Facility (TALF), including commercial mortgage securities and collateralized loan obligations. As such, the Fed will purchase "the country's worst shopping malls and some of the most indebted companies

The Fed's response to COVID-19 has improved the chances of the Fed's balance sheet remaining enormous for a long time to come. Returning to "usual" will entail a shrinkage of the balance sheet and a return to a corridor-like operating system restoring the relation between the balance sheet and monetary policy

The COVID-19 pandemic has resulted in an unprecedented expansion of Fed control and power. It has contributed to the shift of tax liability to the Fed and undermined the independence of the Fed. As compared to pure monetary policy (i.e. allowing the size of the balance sheet to control liquidity, markets, and nominal GDP), the drift into fiscal policy and credit allocation puts the Fed in a precarious position. The lack of a monetary system based on guidelines raises instability and exposes the Fed to more politicisation. So much is asked about monetary policy and too little blame for tough fiscal decisions is put on Congress.

Rahul Sunny answered 8 months ago

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