COVID 19 and Monetary Policy

In the previous article, we have already discussed how fiscal policy can be used to deal with the coronavirus crisis. We understood that the government would be facing a lot of challenges on the fiscal front. Hence, the usefulness of the fiscal policy will be quite limited. Just like fiscal policy, monetary policy is also a tool that can be used by the government to reduce the financial losses arising from the coronavirus crisis.

Unlike the fiscal policy, there are not many limitations with regard to this policy. This is the reason that the Federal Reserve Bank of the United States has already started taking action. Some of the steps taken by the Federal Reserve, as well as the impact that they are likely to have on the economy, have been discussed in this article.

Monetary Policy Measures Undertaken by the Fed

  1. Fed Funds Rate: The fed funds rate is the benchmark rate, which is used for borrowing and lending by entities in the United States. The Fed has brought the rate at close to zero percent. This has been done to ensure that the amount of money circulating in the economy does not reduce. This move is aimed at encouraging businesses and individuals to borrow money even at the time of crisis.

    As far as the consumers are concerned, the rate cuts would mean that their mortgages, student loan payments, and other loans just got cheaper. This will help put more money in the hands of the consumers. This is very important since only high disposable income can increase sales, which would be necessary to bring the economy out of the recession that it is in now.

  2. The problem with this policy is that it cannot continue like this for too long. This is because lower borrowing costs also mean lower interest payments. This reduces the income of all people who are dependent upon interest as their major source of income. Also, if the interest rate is kept low for extended periods of time, it would increase the inflation rate. A spike in the inflation rate can be as damaging to the economy as a recession.

  3. Quantitative Easing: Quantitative easing is a policy tool that the Fed has started using after the 2008 crisis. Under this policy, the Fed buys large amounts of securities from the open market. By purchasing these securities, the Fed puts money in the hands of the people holding them. This also adds liquidity to the market. For instance, the Fed is about to purchase close to $700 billion in treasury bills as well as mortgage-backed securities from the market. The Fed has assured the market that it will focus on mortgage-backed securities. This has been done to ensure that the finance to housing units all over the United States remains unhindered.

  4. Credit Facility: The Fed has learned its lesson from the 2008 crisis. Last time, the big financial institutions did not have any money to lend. As a result, credit markets across the United States froze. This time, the Fed does not want to repeat its mistake. This is the reason why it has decided to offer credit facilities to some of the biggest financial institutions in the United States, known as the primary dealers.

    These institutions can avail of low-cost credit from the United States government for a period of up to three months. This move is aimed at assuring the market that no matter how bad the coronavirus crisis gets, the credit markets will not freeze. The Fed is ensuring that the interests of the taxpayer are not being jeopardized in the process. The primary dealers will have to submit collateral to the Fed in order to back up the loans that they take from it.

  5. Repo Rate: The Fed has also greatly expanded its repo rate operations. Prior to the coronavirus crisis, the Fed was offering up to $100 billion in the overnight repo and $20 billion in the two-week repo. However, going forward, the Fed is willing to expand its repo programs by as much as ten times. This means that the amount of money offered in the overnight repo market is expected to be close to $1 trillion! Also, $500 billion is being offered in the one month and three-month repo market.

  6. Money Market Funds: The Fed is willing to lend to banks against short term money market securities. This is being done because investors are exiting these funds en masse. This is the reason why funds are being forced to sell securities in order to return the money to the investors. However, since so many funds are selling their securities all at once, the values are dropping down regardless of the quality of the assets. To avoid this, the Fed is allowing banks to borrow against money market securities. Hence, they are not forced to sell all at once. This is helping stabilize the money market. This not only helps the banks but also the big corporations who would be unable to sell securities and raise more debt if it weren’t for the Fed’s policies.

The bottom line is that the Fed has been very proactive in dealing with the coronavirus crisis. It has enabled the United States government to offer $2 trillion in the bailout package. The central banks in other nations need to learn from the Fed and follow suit.

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