Question

This is based on the Covid-19 Pandemic. Is there any role that monetary and/or fiscal policy could play? On this respect, describe one action taken by the Federal Government and one action taken by the Federal Reserve to counter the coming recession. Do you think these actions will be successful? What specific issues are the designed to address? What potential problems do you see with these actions?

Answer 1

Fiscal Policy

The US is facing a increasing epidemic of COVID-19, which took the lives of some 46,000 Americans and infected more than 828,000 people in all 50 states. In response, the U.S. has introduced a number of initiatives, including travel bans, social barriers, declaration of state of emergency, closing of schools, bars and restaurants, and increased monitoring. US$484 billion Paycheck Protection Program and Health Care Enhancement Act . The legislation includes (i) US$310 billion for additional forgivable Small Business Administration loans and guarantees to help small businesses that retain workers; (ii) US$60 billion to provide Small Business Administration grants to assist small businesses; (iii) US$75 billion for hospitals; and (iv) US$25 billion for expanding virus testing. An estimated US$2.3 trillion (around 11% of GDP) Coronavirus Aid, Relief and Economy Security Act (“CARES Act”) . The Act includes (i) US$250 billion to provide one-time tax rebates to individuals; (ii) US$250 billion to expand unemployment benefits; (iii) US$24 billion to provide a food safety net for the most vulnerable; (iv) US$510 billion to prevent corporate bankruptcy by providing loans, guarantees, and backstopping Federal Reserve 13(3) program; (v) US359 billion in forgivable Small Business Administration loans and guarantees to help small businesses that retain workers; (vi) US$100 billion for hospitals, (vii) US$150 billion in transfers to state and local governments and (viii) US$49.9 billion for international assistance (including SDR28 billion for the IMF’s New Arrangement to Borrow). US$8.3 billion Coronavirus Preparedness and Response Supplemental Appropriations Act and US$192 billion Families First Coronavirus Response Act . They together provide around 1% of GDP for: (i) Virus testing; transfers to states for Medicaid funding; development of vaccines, therapeutics, and diagnostics; support for the Centers for Disease Control and Prevention responses. (ii) 2 weeks paid sick leave; up to 3 months emergency leave for those infected (at 2/3 pay); food assistance; transfers to states to fund expanded unemployment insurance. (iii) Expansion of Small Business Administration loan subsidies. And (iv) US$1.25 billion in international assistance. In addition, federal student loan obligations have been suspended for 60 days.

Monetary Policy

The pace of Federal Funds was reduced by 150bp in March to 0-0.25bp. Purchase of Treasury and Agency securities in the sum required. Extended overnight and term rest. Higher rate of discount window lending. Reduced existing swap line costs with major central banks and expanded the duration of FX operations; expanded U.S. dollar swap lines to more central banks; offered temporary repo facility for foreign and international monetary authorities. Federal Reserve also introduced facilities to support the flow of credit, in some cases backed by the Treasury using funds appropriated under the CARES Act. The facilities are: (i) Commercial Paper Funding Facility to facilitate the issuance of commercial paper by companies and municipal issuers; (ii) Primary Dealer Credit Facility to provide financing to the Fed’s 24 primary dealers collateralized by a wide range of investment grade securities; (iii) Money Market Mutual Fund Liquidity Facility (MMLF) to provide loans to depository institutions to purchase assets from prime money market funds (covering highly rated asset backed commercial paper and municipal debt); (iv) Primary Market Corporate Credit Facility to purchase new bonds and loans from companies; (v) Secondary Market Corporate Credit Facility to provide liquidity for outstanding corporate bonds; (vi) Term Asset-Backed Securities Loan Facility to enable the issuance of asset-backed securities backed by student loans, auto loans, credit-card loans, loans guaranteed by the Small Business Administration, and certain other assets.

Supervisory behavior. Federal banking supervisors allowed depository institutions to use their capital and liquidity reserves to lend, to collaborate constructively with borrowers impacted by COVID-19, and suggested that improvements to COVID-19 related loans should not be categorized as distressed debt restructuring. U.S. Securities. Treasury securities and deposits in the Federal Reserve Banks may be automatically removed from the calculation of the additional leverage ratio for holding companies. Other measures include providing regulatory relief for reporting and changing the supervisory strategy to minimize the scope and frequency of inspections on a temporary basis and provide sufficient time for non-critical resolution. Regulatory intervention, please. Lower the leverage ratio of the Community Bank to 8%. Provide an extension move to the Present Expected Credit Loss Accounting Policy. PPP loans covered would carry a zero percent risk weight and assets gained and ultimately pledged as collateral to MMLF and PPPLF facilities do not contribute to additional regulatory capital requirements.  Allow early adoption of "the standardized approach for measuring counterparty credit risk". And there will be a gradual phase-in of restrictions on distributions when a firm's capital buffer declines. Fannie Mae and Freddie Mac reported assistance to lenders, including the introduction of 12-month mortgage defaults and the waiving of associated late fees, the cessation of default reporting to credit bureaus, the cessation of 60-day foreclosures and evictions of homeowners, and the availability of credit adjustment options. The big question is whether this rise was simply due to a temporary liquidity problem in the financial system, which can be explained by the smaller supply of funds in the interbank market by public sector banks (which was later partly reversed), or if instead it reflects a change in the monetary and financial conditions which would indicate that this is the beginning of a process of rising interest rates, as has been predicted.

Addressing the crisis in developing countries

Developing countries should start by implementing a national response plan focusing on these four interrelated spheres: Health; the supply and demand of essential goods and services; the domestic financial circuit in local currency; and the foreign currency market, linked to international trade and external debt. Such a plan requires a centralized crisis-management office led by the president, prime minister, or equivalent, with the participation of the relevant public and private sector representatives. This is easier said than done, but it is the only way to avoid uncoordinated actions and working at cross purposes.

Here I will focus on the latter three spheres, acknowledging that there are interactions with health measures, as well as short term trade-offs between health controls and economic activity. everything indicates that we are reaching the end of a cycle and that from now on the Central Bank will encounter monetary policy dilemmas in most decisions. These decisions will involve important tradeoffs between different policy objectives. For example, if they opt for high levels of liquidity to maintain low interest rates, the risk is losing international reserves and hence facing exchange rate pressures, or a rise in inflation. If instead they choose to tighten monetary policy to dissuade the purchase of dollars and to maintain the stock of international reserves, the cost will be accepting an increase in interest rates. Within these dilemmas we do not include the fulfillment of the monetary program, as we do not believe that the Central Bank has it as one of its priorities. The main trigger for the change in the monetary scenario has been the increase in the demand for dollars, which was in part driven by expectations of an increase in the rate of devaluation of the peso and that not by chance coincided with the end of a large sale of the bulk of the soybean harvest.

Increases in domestic prices and costs (especially wages) well above currency depreciation have led to inflation in the dollar and have begun to raise questions about the competitiveness of the peso. In many words, the current exchange rate is starting to affect the ability of many sectors of the economy to export. In recent weeks, this seems to have been the choice of the Central Bank. In recent auctions of Nobacs and Lebacs the maturities were only partially renewed, which injected pesos into the market to avoid pressures on interest rates. In the last three weeks, the base expanded by almost AR$ 3 billion this way.