What Are Three Ways the Fed Can Take Action to Avert a Looming Recession

Editor's Notation:

Jeffrey Cheng, Tyler Powell, and David Skidmore contributed to earlier versions of this mail service.

The coronavirus crisis in the U.s.—and the associated business closures, event cancellations, and work-from-home policies—triggered a deep economic downturn. The sharp contraction and deep doubt about the form of the virus and economy sparked a "dash for cash"—a desire to hold deposits and merely the most liquid assets—that disrupted financial markets and threatened to make a dire situation much worse. The Federal Reserve stepped in with a wide assortment of deportment to continue credit flowing to limit the economic damage from the pandemic. These included big purchases of U.S. regime and mortgage-backed securities and lending to support households, employers, fiscal market participants, and land and local governments. "Nosotros are deploying these lending powers to an unprecedented extent [and] … will go on to use these powers forcefully, proactively, and aggressively until nosotros are confident that we are solidly on the road to recovery," Jerome Powell, chair of the Federal Reserve Board of Governors, said in April 2020. In that same calendar month, Powell discussed the Fed's goals during a webinar at the Brookings' Hutchins Center on Fiscal and Monetary Policy. This mail summarizes the Fed's actions though the end of 2021.

HOW DID THE FED SUPPORT THE U.Due south. ECONOMY AND Fiscal MARKETS?

Easing Monetary Policy

• Federal funds charge per unit: The Fed cutting its target for the federal funds rate, the rate banks pay to borrow from each other overnight, past a total of 1.5 percentage points at its meetings on March 3 and March xv, 2020. These cuts lowered the funds charge per unit to a range of 0% to 0.25%. The federal funds rate is a benchmark for other short-term rates, and also affects longer-term rates, so this move was aimed at supporting spending by lowering the cost of borrowing for households and businesses.
• Forrard guidance: Using a tool honed during the Not bad Recession of 2007-09, the Fed offered forward guidance on the future path of interest rates. Initially, it said that it would keep rates about nada "until it is confident that the economy has weathered recent events and is on runway to achieve its maximum employment and price stability goals." In September 2020, reflecting the Fed's new monetary policy framework, it strengthened that guidance, saying that rates would remain low "until labor market weather condition have reached levels consequent with the Committee'south assessments of maximum employment and inflation has risen to two percent and is on rail to moderately exceed 2 percent for some time." By the terminate of 2021, aggrandizement was well higher up the Fed's 2% target and labor markets were nearing the Fed's "maximum employment" target. At its December 2022 coming together, the Fed's policy-making committee, the Federal Open Market Committee (FOMC), signaled that most of its members expected to heighten interest rates in three one-quarter percentage bespeak moves in 2022.
• Quantitative easing (QE): The Fed resumed purchasing massive amounts of debt securities, a primal tool it employed during the Great Recession. Responding to the acute dysfunction of the Treasury and mortgage-backed securities (MBS) markets later on the outbreak of COVID-19, the Fed's actions initially aimed to restore shine functioning to these markets, which play a critical role in the flow of credit to the broader economy as benchmarks and sources of liquidity. On March 15, 2020, the Fed shifted the objective of QE to supporting the economy. It said that it would purchase at least $500 billion in Treasury securities and $200 billion in authorities-guaranteed mortgage-backed securities over "the coming months." On March 23, 2020, it made the purchases open up-ended, saying it would buy securities "in the amounts needed to support smooth market place operation and effective transmission of budgetary policy to broader financial conditions," expanding the stated purpose of the bond buying to include bolstering the economy. In June 2020, the Fed prepare its rate of purchases to at to the lowest degree $80 billion a month in Treasuries and $40 billion in residential and commercial mortgage-backed securities until further find. The Fed updated its guidance in December 2022 to indicate information technology would tiresome these purchases one time the economy had fabricated "substantial further progress" toward the Fed'due south goals of maximum employment and price stability. In November 2021, judging that test had been met, the Fed began tapering its stride of asset purchases by $x billion in Treasuries and $5 billion in MBS each month. At the subsequent FOMC meeting in December 2021, the Fed doubled its speed of tapering, reducing its bond purchases by $xx billion in Treasuries and $ten billion in MBS each month.

Supporting Financial Markets

• Lending to securities firms: Through the Principal Dealer Credit Facility (PDCF), a program revived from the global financial crisis, the Fed offered low interest rate loans upward to 90 days to 24 large fiscal institutions known as principal dealers. The dealers provided the Fed with diverse securities every bit collateral, including commercial paper and municipal bonds. The goal was to help these dealers keep to play their role in keeping credit markets operation during a time of stress. Early in the pandemic, institutions and individuals were inclined to avoid risky assets and hoard cash, and dealers encountered barriers to financing the ascent inventories of securities they accumulated as they made markets. To re-establish the PDCF, the Fed had to obtain the approving of the Treasury Secretary to invoke its emergency lending authority under Section 13(3) of the Federal Reserve Deed for the commencement time since the 2007-09 crisis. The programme expired on March 31, 2021.
• Backstopping money marketplace mutual funds: The Fed besides re-launched the crisis-era Money Marketplace Mutual Fund Liquidity Facility (MMLF). This facility lent to banks against collateral they purchased from prime money market funds, which invest in Treasury securities and corporate short-term IOUs known as commercial paper. At the onset of COVID-xix, investors, questioning the value of the individual securities these funds held, withdrew from prime money market funds en masse. To meet these outflows, funds attempted to sell their securities, but marketplace disruptions made it difficult to find buyers for even high-quality and shorter-maturity securities. These attempts to sell the securities just drove prices lower (in a "fire sale") and closed off markets that businesses rely on to raise funds. In response, the Fed gear up upwardly the MMLF to "assist money market funds in coming together demands for redemptions past households and other investors, enhancing overall market place functioning and credit provision to the broader economy." The Fed invoked Section 13(3) and obtained permission to administer the program from Treasury, which provided $10 billion from its Commutation Stabilization Fund to encompass potential losses. Given limited usage, the MMLF expired on March 31, 2021.
• Repo operations: The Fed vastly expanded the scope of its repurchase agreement (repo) operations to funnel cash to money markets. The repo market place is where firms borrow and lend cash and securities short-term, unremarkably overnight. Since disruptions in the repo market can affect the federal funds charge per unit, the Fed'southward repo operations made greenbacks bachelor to primary dealers in commutation for Treasury and other government-backed securities. Before coronavirus turmoil hit the market, the Fed was offering $100 billion in overnight repo and $20 billion in ii-week repo. Throughout the pandemic, the Fed significantly expanded the program—both in the amounts offered and the length of the loans. In July 2021, the Fed established a permanent Continuing Repo Facility to backstop money markets during times of stress.
• Strange and International Monetary Authorities (FIMA) Repo Facility: Sales of U.S. Treasury securities past foreigners who wanted dollars added to strains in coin markets. To ensure foreigners had access to dollar funding without selling Treasuries in the marketplace, the Fed in July 2022 established a new repo facility called FIMA that offers dollar funding to the considerable number of foreign central banks that exercise not take established swap lines with the Fed. The Fed makes overnight dollar loans to these fundamental banks, taking Treasury securities as collateral. The central banks tin then lend dollars to their domestic fiscal institutions.
• International swap lines: Using another tool that was important during the global financial crisis, the Fed made U.S. dollars bachelor to foreign central banks to improve the liquidity of global dollar funding markets and to help those government support their domestic banks who needed to raise dollar funding. In exchange, the Fed received foreign currencies and charged interest on the swaps. For the five central banks that accept permanent swap lines with the Fed—Canada, England, the Eurozone, Japan, and Switzerland—the Fed lowered its interest charge per unit and extended the maturity of the swaps. Information technology likewise provided temporary swap lines to the central banks of Australia, Brazil, Denmark, Mexico, New Zealand, Norway, Singapore, South Korea, and Sweden. In June 2021, the Fed extended these temporary swaps until December 31, 2021.

Encouraging Banks to Lend

• Direct lending to banks: The Fed lowered the charge per unit that information technology charges banks for loans from its discount window by 2 percentage points, from 2.25% to 0.25%, lower than during the Bully Recession. These loans are typically overnight—meaning that they are taken out at the end of one day and repaid the following morning—but the Fed extended the terms to xc days. At the discount window, banks pledge a wide variety of collateral (securities, loans, etc.) to the Fed in exchange for cash, so the Fed takes little (or no) hazard in making these loans. The cash allows banks to keep functioning, since depositors can continue to withdraw money and the banks can brand new loans. However, banks are sometimes reluctant to borrow from the discount window because they fear that if word leaks out, markets and others volition think they are in trouble. To counter this stigma, viii big banks agreed to infringe from the disbelieve window in March 2020.
• Temporarily relaxing regulatory requirements: The Fed encouraged banks—both the largest banks and community banks—to dip into their regulatory uppercase and liquidity buffers to increment lending during the pandemic. Reforms instituted subsequently the financial crisis crave banks to agree boosted loss-absorbing capital to prevent future failures and bailouts. However, these reforms besides include provisions that allow banks to use their capital buffers to support lending in downturns. The Fed supported this lending through a technical change to its TLAC (total loss-absorbing capacity) requirement—which includes uppercase and long-term debt—to gradually phase in restrictions associated with shortfalls in TLAC. (To preserve capital, big banks also suspended buybacks of their shares.) The Fed too eliminated banks' reserve requirement—the percentage of deposits that banks must hold as reserves to run into cash need—though this was largely irrelevant because banks held far more than than the required reserves. The Fed restricted dividends and share buybacks of bank belongings companies throughout the pandemic, just lifted these restrictions effective June xxx, 2021, for well-nigh firms based on stress exam results. These stress tests showed that banks had aplenty capital to back up lending even if the economy performed far weaker than anticipated.

Supporting Corporations and Businesses

• Directly lending to major corporate employers: In a significant step across its crisis-era programs, which focused primarily on financial market functioning, the Fed established two new facilities to support the menstruation of credit to U.S. corporations on March 23, 2020. The Chief Market Corporate Credit Facility (PMCCF) immune the Fed to lend directly to corporations past ownership new bond issues and providing loans. Borrowers could defer interest and principal payments for at least the first six months then that they had cash to pay employees and suppliers (but they could not pay dividends or buy dorsum stock). And, nether the new Secondary Marketplace Corporate Credit Facility (SMCCF), the Fed could purchase existing corporate bonds too as commutation-traded funds investing in investment-class corporate bonds. An orderly secondary market was seen every bit helping businesses access new credit in the master market. These facilities allowed "companies access to credit so that they are better able to maintain business operations and chapters during the catamenia of dislocations related to the pandemic," the Fed said. Initially supporting $100 billion in new financing, the Fed appear on Apr 9, 2020, that the facilities would be increased to backstop a combined $750 billion of corporate debt. And, as with previous facilities, the Fed invoked Section 13(3) of the Federal Reserve Act and received permission from the U.S. Treasury, which provided $75 billion from its Exchange Stabilization Fund to encompass potential losses. Late in 2020, afterwards the recovery from the pandemic was under way, and despite the Fed's misgivings, Treasury Secretarial assistant Steven Mnuchin decided that the concluding bail and loan purchases for the corporate credit facilities would have place no later than December 31, 2020. The Fed objected to the cutoff, preferring to go on the facilities available until in that location was a firmer assurance that financial conditions would not deteriorate again. The Fed said on June 2, 2021 that it would gradually sell off its $13.7 billion portfolio of corporate bonds, which it completed in Dec 2021.
• Commercial Newspaper Funding Facility (CPFF): Commercial paper is a $one.2 trillion market in which firms issue unsecured brusk-term debt to finance their day-to-day operations. Through the CPFF, some other reinstated crisis-era program, the Fed bought commercial paper, essentially lending directly to corporations for up to 3 months at a rate 1 to 2 percent points higher than overnight lending rates. "By eliminating much of the hazard that eligible issuers will non be able to repay investors past rolling over their maturing commercial paper obligations, this facility should encourage investors to once over again engage in term lending in the commercial paper market," the Fed said. "An improved commercial newspaper market place will enhance the ability of businesses to maintain employment and investment every bit the nation deals with the coronavirus outbreak." As with other non-bank lending facilities, the Fed invoked Section 13(3) and received permission from the U.S. Treasury, which put $ten billion into the CPFF to cover any losses. The Commercial Paper Funding Facility lapsed on March 31, 2021.
• Supporting loans to small- and mid-sized businesses: The Fed'due south Principal Street Lending Program, announced on April nine, 2020, aimed to back up businesses also large for the Pocket-sized Concern Administration's Paycheck Protection Program (PPP) and too small for the Fed's 2 corporate credit facilities. The program was subsequently expanded and broadened to include more potential borrowers. Through three facilities—the New Loans Facility, Expanded Loans Facility, and Priority Loans Facility—the Fed was prepared to fund up to $600 billion in v-year loans. Businesses with upwardly to 15,000 employees or up to $5 billion in annual revenue could participate. In June 2020, the Fed lowered the minimum loan size for New Loans and Priority Loans, increased the maximum for all facilities, and extended the repayment period. As with other facilities, the Fed invoked Section 13(iii) and received permission from the U.S. Treasury, which through the CARES Act put $75 billion into the 3 Main Street Programs to cover losses. Borrowers are subject field to restrictions on stock buybacks, dividends, and executive bounty. (Run across here for boosted operational details.) Secretarial assistant Mnuchin, again over the Fed's objections, decided that the Main Street facility would end taking loan submissions on December fourteen, 2020, as it was set up to make its final purchases past January eight, 2021. The Fed too established a Paycheck Protection Program Liquidity Facility that facilitated loans made under the PPP. Banks lending to small businesses could infringe from the facility using PPP loans as collateral. The PPP Liquidity Facility closed on July xxx, 2021.
• Supporting loans to non-profit institutions: In July 2020, the Fed expanded the Main Street Lending Plan to non-profits, including hospitals, schools, and social service organizations that were in sound financial condition before the pandemic. Borrowers needed at least ten employees and endowments of no more $3 billion, amidst other eligibility conditions. The loans were for 5 years, only payment of primary was deferred for the first ii years. Equally with loans to businesses, lenders retained 5 pct of the loans. This addition to the Principal Street program lapsed with the rest of the facility on January 8, 2021.

Supporting Households and Consumers

• Term Nugget-Backed Securities Loan Facility (TALF): Through this facility, reestablished on March 23, 2020, the Fed supported households, consumers, and minor businesses by lending to holders of nugget-backed securities collateralized by new loans. These loans included pupil loans, auto loans, credit card loans, and loans guaranteed by the SBA. In a step across the crisis-era program, the Fed expanded eligible collateral to include existing commercial mortgage-backed securities and newly issued collateralized loan obligations of the highest quality. Like the programs supporting corporate lending, the Fed said the TALF would initially support up to $100 billion in new credit. To restart information technology, the Fed invoked Department thirteen(three) and received permission from the Treasury, which allocated $10 billion from the Exchange Stabilization Fund to finance the program. Without an extension, this facility stopped making purchases on December 31, 2020, at Secretary Mnuchin'south order.

Supporting Land and Municipal Borrowing

• Direct lending to state and municipal governments: During the 2007-09 fiscal crisis, the Fed resisted backstopping municipal and state borrowing, seeing that equally the responsibility of the administration and Congress. Merely in this crisis, the Fed lent direct to state and local governments through the Municipal Liquidity Facility, which was created on Apr 9, 2020. The Fed expanded the list of eligible borrowers on April 27 and June 3, 2020. The municipal bond marketplace was under enormous stress in March 2020, and country and municipal governments found it increasingly difficult to borrow equally they battled COVID-19. The Fed'south facility offered loans to U.S. states, including the District of Columbia, counties with at to the lowest degree 500,000 residents, and cities with at least 250,000 residents. Through the programme, the Fed made $500 billion available to government entities that had investment-grade credit ratings as of April 8, 2020, in exchange for notes tied to future tax revenues with maturities of less than three years. In June 2020, Illinois became the first authorities entity to tap the facility. Nether changes announced that month, the Fed allowed governors in states with cities and counties that did not meet the population threshold to designate up to two localities to participate. Governors were besides able to designate ii revenue bond issuers—airports, cost facilities, utilities, public transit—to exist eligible. The New York Metropolitan Transportation Authority (MTA) took reward of this provision in August, borrowing $451 million from the facility. The Fed invoked Department 13(3) with the blessing of the U.S. Treasury, which used the CARES Act to provide $35 billion to encompass any potential losses. (See here for additional details.) The Municipal Liquidity Facility stopped purchases on December 31, 2020 when it lost Treasury support, per Secretary Mnuchin's determination. The New York MTA secured a 2nd loan from the facility on December 10, 2020, borrowing $2.9 billion before lending halted.
• Supporting municipal bond liquidity: The Fed as well used 2 of its credit facilities to backstop muni markets. It expanded the eligible collateral for the MMLF to include municipal variable-rate demand notes and highly rated municipal debt with maturities of up to 12 months. The Fed also expanded the eligible collateral of the CPFF to include high-quality commercial newspaper backed by tax-exempt country and municipal securities. These steps immune banks to funnel cash into the municipal debt marketplace, where stress had been building due to a lack of liquidity.

WHY WERE THE FED'Southward Actions IMPORTANT?

Steps taken by federal, state, and local officials to mitigate the spread of the virus express economic activity, leading to a sudden and deep recession with millions of jobs lost. The Fed's actions ensured that credit continued to flow to households and businesses, preventing financial market disruptions from intensifying the economic damage.

In many other countries, most credit flows through the banking system. In the U.S., a substantial amount of credit flows through upper-case letter markets, so the Fed worked to keep them performance equally smoothly equally possible. As ane of our colleagues, Don Kohn, erstwhile Federal Reserve Vice Chair, said in March 2020:

"The Treasury market in particular is the foundation for trading in many other securities markets in the U.Southward. and around the world; if it's disrupted, the functioning of every market will exist impaired. The Fed'southward purchase of securities is explicitly aimed at improving the functioning of the Treasury and MBS markets, where market place liquidity had been well beneath par in recent days."

Simply targeting the Treasury market proved insufficient, given the severity of the COVID recession and the disruption of flows of credit across other financial markets. And then the Fed intervened directly in the markets for corporate and municipal debt to ensure that key economic actors could raise funds to pay workers and avert bankruptcies. These measures aimed to assistance businesses survive the crisis and resume hiring and production when the pandemic ebbed.

Banks besides needed support to keep credit flowing. When financial markets are chock-full, firms tend to draw on bank lines of credit, which tin can lead banks to pull back on lending or selling Treasury and other securities. The Fed supplied unlimited liquidity to financial institutions so they could meet credit drawdowns and make new loans to businesses and households feeling financial strains.

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The authors did not receive financial support from whatsoever house or person for this article or from whatever firm or person with a fiscal or political interest in this article. They are not currently an officers, directors, or board members of any organisation with a financial or political interest in this article. Prior to his consulting work for Brookings, Dave Skidmore was employed by the Lath of Governors of the Federal Reserve Organisation.

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Source: https://www.brookings.edu/research/fed-response-to-covid19/

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