Today’s dramatic Federal Reserve announcements, explained

They include big new lending programs — but state and local governments are left out of the party.

Early Monday morning before financial markets opened, the Federal Reserve announced a dramatic series of moves designed to promote economic stability as the coronavirus pandemic continues to batter the US economy, sending unemployment claims skyrocketing and pushing the economy into recession.

The spirit of today’s announcement is basically: pull all the levers.

The Fed’s moves are dramatic, somewhat complicated, and unprecedented but they have a pretty simple purpose — try to make it cheap for all kinds of entities to get loans while hoping public health officials can get the virus under control and Congress can act to provide the kinds of economic support that only it can offer.

But for all that the Fed is doing — an alphabet soup of new, revived, and expanded programs involving eye-popping sums of money — it’s also noteworthy that monetary policymakers aren’t doing anything to deviate from the same basic inflation targeting paradigm they’ve used for decades now. It will help offer reassurance to the world that nothing too crazy is going on here, hopefully bolstering the political legitimacy of dramatic new steps. But it also likely blunts the real-world impact of these measures. In this case going even further to include financial support to state and local governments, or announcing that the central bank is moving beyond its long-time emphasis on inflation targeting could be even better.

It starts with unlimited QE

For a long time the Federal Reserve’s approach to stabilizing the economy was largely limited to setting short-term interest rates. During the Great Recession, short-term rates went to zero and the economy was still depressed. That led the Fed to undertake multiple rounds of what’s somewhat confusingly come to be known as “quantitative easing” which basically means the Fed announces it’s going to buy such-and-such billion dollars worth of longer-term bonds and then goes out and does that.

Interest rates were already low at the start of the coronavirus crisis, so the Fed cut rates on March 3 and then cut rates again, all the way down to zero on March 15. Then it rapidly announced a plan for $700 billion in quantitative easing — $500 billion worth of US government bonds and $200 billion worth of bonds issued by Fannie Mae and Freddie Mac (these are called “agency-backed securities” in Fedspeak).

Monday’s announcement expanded the QE program in two ways. First, it uncapped the quantity of quantitative easing, saying simply that the Fed “will 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.” Second, it is expanding the scope of what can be purchased to include commercial real estate (things like officers and stores) backed by Fannie and Freddie to ensure low interest rates throughout the sector.

But wait, there’s more!

A bunch of new programs

In traditional monetary policy, short-term interest rates are the lever that moves the whole economy. Rates on long-term government bonds go down when short-term rates go down, and rates on corporate debt go down when rates on government debt go down. So even though the short-term rates are not themselves particularly important, the workings of profit-seeking traders ensure that the impact propagates throughout the economy.

QE exists as an alternative means of impacting long-term rates without trying to make short-term rates go below zero (which runs the risk that people will resort to storing physical cash in vaults rather than suffering negative rates). But the Fed is also worried that there is so much fear in financial markets that the economic impact won’t propagate naturally. So they are launching a huge alphabet soup of credit facilities.

• The Primary Market Corporate Credit Facility (PMCCF) will buy newly issued corporate bonds, typically from large employers.
• The Secondary Market Corporate Credit Facility (SMCCF) will buy existing corporate bonds to give people confidence that this remains a “liquid” market and thus they don’t need to panic sell corporate debt they already own, or fear buying new debt from creditworthy companies.
• The Term Asset-Backed Securities Loan Facility will buy asset-backed securities (basically packages of loans) composed of student loans, auto loans, credit card loans, and other forms of consumer debt plus some Small Business Administration loans.
• The Money Market Mutual Fund Liquidity Facility will expand the range of things it buys to include a kind of municipal bond called a “municipal variable rate demand note” as well as bank certificates of deposit, which are basically medium-term loans consumers make to retail banks.
• The Commercial Paper Funding Facility is going to expand to include “high-quality, tax-exempt commercial paper,” which is a kind of business debt that allows state and local governments to create tax subsidies for businesses.

All that is happening today.

Meanwhile, the Fed is not quite ready to explain the details or launch, but it also previewed that it expects “to announce soon the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the SBA [Small Business Administration.”

It’s not entirely clear what that will look like. But it exemplifies the spirit of Monday’s announcement, which is basically, pull all the levers. 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. But today’s Fed isn’t taking chances with either the economic impact or the impact on political legitimacy. 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.

But there’s one big exception — state and local governments.

A glaring missing piece

The Federal Reserve has been clear for weeks that it cannot tackle the problems facing the economy alone and it wants support from fiscal policy — stimulus measures enacted by the United States Congress.

But Congress is not the only government actor in the US. States and localities have tremendous leverage and they actually do much more direct employment than the federal government. Cops, firefighters, teachers, and librarians are primarily employed by local governments, and construction projects on roads and other infrastructure are largely financed through state government.

As Skanda Amarnath, the director of research & analysis at Employ America and a former New York Fed research analyst points out, the glaring exception to the Fed’s new aggressiveness is it is doing very little on state and local debt even though it has the legal authority to help here.

Michael Mandowitz, an economist with the Center for American Progress, tweets that “after all the complaining about fiscal policy, the Fed is not doing enough to prevent austerity as it’s happening.”

Progressives have long called for the Federal Reserve to expand its toolkit to include more support for state and local government. During the Great Recession, balanced budget rules forced massive cuts in state/local spending (plus some tax increases in the more progressive states) which generally meant that in the aggregate, the public sector was removing support from the economy despite the big federal stimulus bill. More support for states and localities was a key plank of a December 2017 report on the Fed from the Roosevelt Institute. Amarnath teamed up with Yakov Feygin of the Berggruen Institute on March 15 to lay out a specific plan for how they could do that within their existing statutory authority — citing powers under Section 14(2)(b) of the Federal Reserve Act.

So far, Federal Reserve Chair Jerome Powell and his team have opted not to do that, largely limiting themselves to powers that exist in Section 13(3) and allow the Fed to support private sector activity. Another limitation to Section 13(3) powers is the way they are written; the Fed can only act in tandem with the Treasury Department. So today’s measures are being backed by the money that’s in the treasury’s Exchange Stabilization Fund, which means there are limits to how much the Fed can actually do without further congressional action. Section 14(2)(b) powers to buy state and local debt could be undertaken immediately and without limitation.

But perhaps the biggest limit on today’s Fed actions is they take place within the context of the same overall framework for monetary policy.

New tools, same rulebook

The Federal Reserve practices what’s known as inflation targeting, meaning it tries to make measured prices rise by about 2 percent per year. That’s often seemed in practice like an inflation ceiling — they try to make measures prices rise by close to but no more than 2 percent per year.

This does not allow for any “catch-up” inflation, where you say that if a deeply depressed economy had extremely slow price growth for a while then you can make up for it by running things hot for longer than you otherwise would. Allowing for catch-up, called level targeting among monetary policy nerds, could bolster the impact of emergency measures by assuring people that the safety net won’t be withdrawn at the first possible opportunity.

Another target switch, advocated by former Obama administration economist Christina Romer, and explained most comprehensively and forcefully by Mercatus’s David Beckworth, would be to forget about inflation altogether and target nominal spending instead.

That would mean saying that a hit to the economy could be taken in the form of increased inflation rather than reduced output. The way the current framework works, for example, if increased demand for soap, hand sanitizer, disinfecting wipes, and bleach spray leads to higher prices, that becomes a reason for monetary policy to do less to support the economy. Similarly, if switching from in-restaurant service to less efficient home delivery raises prices, that’s inflation which the Fed is supposed to fight. In the current phase of the economic situation this doesn’t make a difference in practice, because the tumbling price of oil and other basic commodities swamps everything else.

There will presumably be a time when some restrictions are lifted but there is not yet a Covid-19 vaccine, and the economy is growing but has not yet bounced back to where it previously was. At that point, prices will start increasing even though total income and spending levels will be lower than they were before the virus hit. Inflation targeting says that’s the top to start doing less monetary stimulus to support the economy, while a nominal spending targets says to push through even if some stuff gets expensive.

On the one hand, this is sort of a problem for another time given the intensity of the current crisis. But on the other hand, both financial markets and on-the-ground investors are at least somewhat forward looking, so the Fed’s guidance for what it is likely to do in the future matters. And despite the radicalism of today’s crisis steps, conservatism about the overall framework of monetary policy continues to limit their potency.