The Federal Reserve along with its major central banking partners moved on Sunday to restore functioning credit markets in an attempt to put a floor under the global economy and calm financial markets.
The Fed announced a restoration of quantitative easing to the tune of $700 billion. In addition, the central bank cut its policy rate by 100 basis points, to a range of zero to .25%. The purchase of $500 billion in Treasuries and $200 billion in agency mortgage-backed securities intends to facilitate a restoration of functioning markets.
Over the past few weeks, the U.S. economy has suffered a four-standard-deviation shock that will require the combined firepower of both the monetary and fiscal authorities to absorb the three different shocks (supply, demand and financial) that are affecting the U.S. and global economies.
Restoring market functioning will not be easy, and it is possible that despite the Fed’s significant intervention it will not change the minds of risk-averse market participants. Nevertheless, the Fed and its central bank partners went large today.
The moves came in a coordinated fashion with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve and the Swiss National Bank — all part of an effort to enhance liquidity through the standing U.S. dollar liquidity swap line arrangements.
We think this is just one of many steps that the Fed, in conjunction with the fiscal authority, will have to take in the coming days to stabilize financial markets and target risk-averse market participants.
We expect Congress and the Treasury to work with the Fed to put a floor under both financial markets and the economy. In our estimation, that will require the fiscal authority to put forward a sizable and creative set of policies to deal with the monumental demand shock that is on the way. We think that the ultimate cost of such a move will be equal to 1.5% to 2% of gross domestic product.
In addition, the central bank moved to open the discount window and dropped the primary credit rate by 150 basis points, to 0.25%, effective Monday.
This reduction in the primary credit rate reflects both the 100 basis point reduction in the target range for the federal funds rate and a 50 basis point narrowing in the primary credit rate relative to the top of the target range. By narrowing the spread of the primary credit rate to the overnight rate, the Fed intends to stimulate demand at the discount window to cover funding needs.
In addition, firms can borrow for 90 days, and the Fed will accept the same broad range of collateral for discount window loans. The Fed reduced reserve requirement ratios to 0%, effective on March 26, and it urged all banks to consider using capital and liquidity buffers to support lending and continue to support households and firms.
