The United States is probably now in the early days of its sharpest recession since 2007-2009, maybe since the 1930s. No one knows how bad it will get because the virulence and spread of the COVID-19 pandemic are virtually unpredictable.
Some experts, including Federal Reserve officials, are looking back at the Fed’s extraordinary — and quite successful — responses to the financial crisis in 2007-2009, and asking for, or doing, a repeat performance. But the analogy doesn’t hold. The roots of the 2008 catastrophe were primarily financial. So financial medicine, applied mainly by the Fed but also by the government through the Troubled Asset Relief Program, was needed. What started as a financial disaster spread into the real economy, and required a big fiscal stimulus.
However, the economic disaster we face today is nothing like that. The pandemic is a major public health emergency. The initial, and most important, responses must be measures that slow the spread of the virus and/or reduce the “peak” that threatens to overwhelm the health system. That includes test kits, ventilators and respirators, beds in intensive care units and social distancing. Because the virus is so contagious, people are pulling away from one another — both naturally and because health authorities urge them to do so. That’s important. But it’s catastrophic for the economy.
The Fed can do nothing to ameliorate that problem. What our central bank is doing is fighting financial brushfires that are side effects of a struggling economy. The Fed knows how to do that: by providing liquidity where needed, by encouraging banks to forbear on delinquent loans, for instance. I am confident it will continue to do those things — and more. But such actions are of tertiary importance today.
It’s not unusual for politicians, financial markets, and even ordinary citizens to expect the Fed to do more than it can. President Donald Trump has fixated on the idea that interest rate cuts are the route to faster growth, and he has bullied the Fed accordingly. Well, he finally has his rate cuts. In fact, he also has 2020 versions of several other emergency measures that the Fed used effectively in 2008-2009, such as quantitative easing (buying long-term bonds) and “forward guidance” (talking long rates down).
Sadly, however, all these pack a lot less punch than they did then — as you can see from the markets’ reactions. When the Fed reduced the federal funds rate by ½ percentage point on March 3, the stock market cheered for about 20 minutes and then tanked. On March 12, when the Fed responded to pleas for more liquidity with huge amounts, the stock market had one of its worst days (though it was perhaps because of Trump’s disastrous March 11 address to the nation). The Fed threw the kitchen sink at the problem Sunday night, and the markets tanked again Monday.
Our country has gotten used to leaning on monetary policy to get out of recessions. Not this time: Public health measures must take first chair. Fiscal measures such as helping the poor, workers who lose their jobs or lack health insurance, and small businesses facing bankruptcy are in second chair. Monetary policy sits in the back seat.
To do more than it has done, the Fed will have to not just think outside the box but actually step out of the box, with emergency lending to banks and distressed businesses. For that to happen, it will need approval from the administration and Congress, which would have to restore emergency powers it eliminated in the Dodd-Frank Act of 2010.
Sadly, the two most lethargic actors in this crisis to date have been Trump and Senate Majority Leader Mitch McConnell. That must change — now.
Alan S. Blinder is a professor of economics and public affairs at Princeton University and a former vice chairman of the Federal Reserve Board.