A brief thought on the necessity of monetary policy as a first responder
We are now two months past when news about the coronavirus began to accelerate over MLK weekend, and US fiscal policy is still far behind the curve. Policymakers have enacted exactly one vital but relatively-tiny $8 billion bill. Congress is about to pass another one today that is larger but watered down from its original size. And discussions are still in early stages over a possible third bill whose magnitude finally looks more promising. Realistically though it will likely still take Congress another two weeks to negotiate and pass it, and several more for the benefits to hit household wallets.
Contrast that with monetary policy. A few weeks ago, the federal funds rate was at 1.5%. Now it’s at 0. There was a limited bills-buying program meant to top off adequate reserves for banks, and the Fed was preparing to phase it out. Now it’s been expanded and converted into full-blown QE. And the Fed was tapering down its repo operations; they’ve now grown by more than an order of magnitude.
All of these actions, plus the revived alphabet soup of credit facilities, have happened outside the Fed’s regularly scheduled March meeting which was supposed to happen today.
Some argue that countercyclical policy actions should entirely come from fiscal policy, and that monetary policy should not be used as a demand-side instrument. The present crisis shows the folly of that view.
To be sure, monetary policy action alone isn’t close to sufficient. The Federal Reserve can’t counteract deep economic shocks on its own, and it certainly isn’t the best mechanism for addressing a pandemic. Even under normal circumstances, rate cuts and QE take many months to fully flow through to the real economy when they work as anticipated. And there are good reasons to think that in the present situation, conventional and unconventional monetary policy tools might prove less effective than normal. Fiscal policy must bear the burden of supporting households and businesses in this crisis, scaled up against the risk that it, too, may prove less potent now than in past downturns.
And there are smart proposals to improve the responsiveness of fiscal policy. Augmented automatic fiscal stabilizers triggered by actual data, like Claudia Sahm’s unemployment rate rule, are an excellent idea that we should have implemented during the recovery, and should certainly implement now.
But triggers are only as responsive as the data that triggers them. As of last week, initial unemployment insurance claims — the highest-frequency quality read on the labor market that we have —had barely budged, staying close to its record lows. We will probably begin to see claims rise in tomorrow’s release, but that will only be the first in what is sure to be a long series of painful hits. We may not see the unemployment rate as measured by the Current Population Survey rise meaningfully for the first time until the April data comes out six weeks from now.
So in the end we now see hour by hour exactly why we need both fiscal policy — discretionary and automatic — as well as monetary policy. Fiscal can scale up indefinitely and be well-targeted, but it moves slowly and can get stuck in political or logistical muck. Central banks meanwhile are not panaceas but can act immediately and preemptively, even before shocks show up the real data. As first responders they can help blunt some economic damage and keep capital from freezing up.
In a crisis like this one we should never lean on central banks entirely or even predominantly. But they’ve been essential to the coronavirus response thus far. We shouldn’t tie our hands in future crises by passing on that tool kit.