March has been a month for the ages – one that fiscal and monetary policymakers will never forget. Congress put forward roughly $2.2 trillion, or equal to 11.4% of gross domestic product, in fiscal aid to address current and coming economic difficulties around the country.
That boost will most likely show up later in the year. Based on past stimulus and aid efforts, we expect a fiscal boost of 3.2% in 2020 and 1.7% in 2021, with the single largest impact occurring late in the fourth quarter of 2020 and early in 2021.
We expect the creation of a trillion-dollar Main Street Lending Program to target small and medium-size enterprises.
Inside that aid package, there is $425 billion committed to provide a backstop for Federal Reserve lending commitments, which the central bank is widely expected to leverage up to $4.25 trillion in lending facilities.
One of those lending facilities that we expect to be set up this week will be a trillion-dollar Main Street Lending Program, which will target small and medium-size enterprises. This essentially is a middle market lending program that intends to ring fence the real economy during what will be the worst phases of the crisis.
Around the world, G-7 finance ministers and central bankers are engaged in concerted and coordinated action on the fiscal and monetary fronts. Central banks with the most policy leeway – the United States, Canada and England — promptly responded by cutting their policy rates by an extraordinary half a percentage point, with the Federal Reserve following up with another 100 basis-point cut to the zero lower bound as the emergency unfolded.
The G-7 leaders appeared to accede to the necessity for both fiscal and monetary responses to the virus. As their transcript said: “Alongside strengthening efforts to expand health services, G-7 finance ministers are ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy during this phase.” And this is what occurred.
Of the $2.2 trillion in fiscal firepower committed to addressing the crisis, $340 billion will go to emergency funding for health care, and state and local governments; $290 billion for cash payments to households; $250 billion for increased unemployment benefits; $232 billion in corporate tax relief; and $500 billion in assistance for hard-hit industries. Inside the $250 billion in increased unemployment insurance is the much talked about four months of unemployment benefits at $600 per week.
Most important, Congress committed roughly $350 billion for small businesses. That will include $10 billion for grants and $17 billion in loan forgiveness.
If you are a small or midsize firm looking for bridge financing to get through the crisis or are in need of potential grants and forgivable loans, please click here for more information or proceed to SBA.GOV for information on disaster assistance.
The federal government has committed $2.39 trillion in aid that includes hard cash backstops that will likely result in $4.25 trillion in liquidity and loan facilities on the part of the central bank. The total aid package so far is equal to 12.4% of GDP. Given the size of the employment shock and the resulting demand shock that is working its way through the economy, we expect there will be other rounds of fiscal aid put forward.
We anticipate that when Congress returns from its break in mid-April, there will be a phase-four package that will target greater than $100 billion in direct relief for the states and municipalities that will be reeling from the loss of tax revenues and are starting to look at austerity measures to balance budgets.
Ohio, for example, has already begun discussing 20% across-the-board cuts in state fiscal outlays. Austerity measures such as this during the current crisis would tend to intensify the economic damage being inflicted on households and firms.
That is exactly the wrong policy path to pursue with the works of the public health and economic damages to the country in front of us. This is why that $100 billion phase four package will most likely grow as the extent of the damage to domestic household spending and the labor market is ascertained.
Why such a large fiscal response?
The fiscal authorities – Congress and the executive branch – can directly respond to the coronavirus and decide whether to expand health care facilities or to expand the social safety net to maintain income levels. Typically, you would expect a longer process for getting those funds into the system, with politics and ideology creating barriers to the response. But the depression-like shock under way necessitated such a broad, deep and sustained fiscal action.
It is important to note that fiscal responses to the economic losses during the crisis are more of an aid package that is attempting to limit the downside risk around bankruptcies, unemployment and lost growth. Of equal importance is that as the economy comes out of the shock, there will need to be a round of stimulus that is separate and distinct from the aid package that was recently signed into law.
Over the long term, it would make sense to look at constructing an infrastructure bank.
That will need to include both short- and long-term policy support. In the near term, aid to the states, the unemployed and efforts to restart global trade by cutting tariffs back to the levels before the trade war will be on the table.
Over the long term, it would make sense to look at constructing an infrastructure bank. With the 10-year yield on U.S. government securities trading between .70% and .80% it would make sense that the government would allocate $75 billion over the next five years to create a $375 billion bank that could then be leveraged up by 10 to 1 to rebuilding the crumbling U.S. infrastructure.
Important to note that following the crisis, policymakers do not anticipate that the unemployment rate will fall back to 3.5%. It is highly likely that the domestic unemployment rate will soar well above 10% by midyear.
The burden of adjustment will be borne by uneducated men 25 to 54 years old who will need employment during what will be an elongated and uneven recovery period. Good policy would target rebuilding the country’s antiquated infrastructure and create the conditions to avoid the social destabilization that has long followed periods of mass unemployment by men in the cohort.
The monetary response
The monetary authority (the Federal Reserve) is independent and most adept at reacting to shocks. It has set up seven lending facilities over the past month and is expected to expand that list in the coming days. It can quickly affect the cost and availability of funds needed to transact business by raising or lowering the overnight rate and by injecting liquidity into money markets that might otherwise freeze up.
Raising and lowering the federal funds policy rate directly affects short-term interest rates at the front end of the yield curve and influences the direction of longer-term interest rates further out along the yield curve. The Fed can also choose to affect the demand and supply of long-dated securities through asset purchases of government bonds (Treasuries and mortgage-backed), further pressuring interest rates at the long end of the yield curve needed for capital investment and supporting economic expansion.
And there will be a call — at some point – to allow the Fed to purchase corporate securities and assets if the virus is not contained and the economy is sinking without control. Thus, it may be up to the more agile monetary authority to react to the evolution of the economic crisis.
According to an analysis by former Fed Vice Chairman Donald Kohn, the 2020 Fed under Chairman Jerome Powell reacted quickly to the health crisis. Having held the world together through the financial crisis of 2007-9, the Fed was prepared and took these actions, Kohn wrote:
- “Lowered its target interest rate by a full percentage point nearly to zero, and provided guidance that rates would remain at this level until ‘it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.’ This move followed a 50-basis-point rate cut on March 3.”
- “Committed to buy $700 billion of Treasury ($500 billion) and agency MBS ($200 billion) securities” that was augmented to become what is essentially open-ended, large-scale asset purchases or quantitative easing.
- “Lowered the cost of the dollar swaps it does with foreign central banks to facilitate borrowing by foreign banks in dollars.”
- “Encouraged banks to borrow from the Fed’s discount window, where it extends credit to banks backed by a wide range of collateral, by reducing the penalty banks pay above market rates and extending the maturity of the loans.”
- “Encouraged banks to utilize intraday credit from the Federal Reserve, that is, to temporarily overdraft their Fed accounts if required. A reluctance to incur such overdrafts was identified as one factor contributing to the repo market turbulence of last September.”
- “Encouraged banks to utilize the buffers of liquidity and capital they have built in recent years to extend loans. In effect, the Fed is saying that, as a bank regulator, will not object to, and indeed is encouraging, drawing on liquidity and capital resources as banks meet the elevated credit needs of their household and business customers.”
- “Reduced banks’ reserve requirements to zero. They were already very low and served no purpose in the “ample reserves” monetary policy regime now being implemented.”
As the figure above illustrates, those actions are transmitted to the real economy via altering financial conditions, with lower interest rates making a more accommodative environment for investing.
It will undoubtedly be argued that the Fed did too little too late, blaming the equity market crash on the Fed keeping rates too high. And the Fed will be blamed for exhausting its tools and its effectiveness in one fell swoop. But that goes along with being a central banker. And in our estimation, the Fed has moved in a far swifter fashion and at depth than during the Bernanke era.
