Question

Do you have a better idea or ideas for a smarter Federal Reserve Bank Monetary economic stimulus policy in response to the COVID-19 virus mess? Or do you think that their current plan is the best plan? If so why?

Answer 1

What more can the Fed do?

The Fed’s powers and tools, as impressive as they are, aren’t sufficient to cope with the economic harm of the COVID-19 crisis. That’s why there has been a big—at least $2 trillion—fiscal response from Congress and the President—support for businesses and checks to every household. As Powell said when the Fed cut rates nearly to zero, “Monetary policy has a role… [but] we do think fiscal response is critical.”

But the Fed may have a few more moves left.

On the monetary policy front, there’s not a lot left. The Fed could cut interest rates below zero—essentially charging a fee for any bank that puts money on deposit at the Fed. Several other central banks have moved to negative rates, but the Fed has said it probably won’t.

It is also unlikely to buy government debt directly from the government as opposed to buying in the secondary market—a process known as monetizing the debt—as the Bank of England has agreed to do, temporarily.

Still, as Ben Bernanke and Janet Yellen, both former Fed chairs and now our colleagues at the Hutchins Center, outlined recently in the Financial Times, there is more that the Fed could do.

Here are some steps the Fed could take:

The Fed still has room to expand its lending facilities. The Treasury initially pledged $50 billion from its Exchange Stabilization Fund to protect the Fed from losses. The $2.2 trillion CARES Act provided Treasury with an additional $454 billion that can be used to backstop the Fed’s programs and the new and expanded programs announced April 9 used $185 billion of that.

Restart the Term Auction Facility, an alternative to the discount window. “Many banks were reluctant to borrow at the discount window out of fear that their borrowing would become known and would be erroneously taken as a sign of financial weakness,” the Fed said. Under the TAF, the Fed auctioned 28-day and, later, 84-day loans to U.S. and foreign banks in generally sound condition. “The TAF enabled the Federal Reserve to provide term funds to a broader range of counterparties and against a broader range of collateral than it could through open market operations. As a result, the TAF helped promote the distribution of liquidity when unsecured bank funding markets were under stress. It also provided access to term credit without the stigma that had been associated with use of the discount window.” Discount window borrowing peaked at a little more than $100 billion during the crisis; TAF borrowing at $450 billion.

Broaden the range of financial firms that can borrow from the PDCF beyond the two dozen firms designated as primary dealers, to include hedge funds and other institutions not currently eligible.

Once an economic recovery is underway, strengthen its forward guidance for maintaining near-zero interest rates and massive securities purchases, either by pledging to continue its extraordinary measures until a specific date or until specific economic or financial conditions are achieved.

The Fed can go beyond forward guidance on its target for the overnight federal funds rates by deploying another policy tool—yield curve control. Yield curve control caps somewhat longer-maturity yields, such as two-year and three-year yields, at low levels by committing to buying whatever amounts of Treasury securities are necessary to cap the rate. The Fed last capped yields during and after World War II but hasn’t done so since 1951. More recently, the policy has been used by the Bank of Japan and the Reserve Bank of Australia.

This is a third party opinion.