Glenn and Donald Kohn on the Report of the Task Force on Financial Stability

   Glenn co-chairs the Task Force on Financial Stability with Donald Kohn, now a fellow at the Brookings Institution and formerly vice-chair of the Board of Governors of the Federal Reserve. The Task Force on Financial Stability was formed by the Initiative on Global Markets at the University of Chicago and the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution to make recommendations intended to increase the stability of the U.S. financial system.

On June 29, 2021, the Task Force issued a report, which can be found HERE. Glenn and Donald Kohn discuss the reports findings in an opinion column published on bloomberg. com.

The Federal Reserve building in Washington, D.C.

Our Financial Early Warning System Is Broken

The U.S. financial system emerged from the reforms that followed the 2008 global crisis stronger than it had been going in. But the onset of the pandemic in March 2020 demonstrated how much was left undone: Although banks weathered the storm well, financial disruptions elsewhere — in money market funds, in the Treasury market — necessitated extraordinary measures to prevent an even greater economic disaster.

A group that we co-chair, the Task Force on Financial Stability, has just released a report on how to make the system more resilient. Among other things, we see the need for a structural change: Overhaul the agencies tasked with identifying and addressing threats outside traditional banks.

The Dodd-Frank financial reform of 2010 created two new entities focused on systemic risk. The Financial Stability Oversight Council, which included the Treasury Secretary and the heads of all the major financial regulatory agencies, was supposed to foster collaboration in finding and fixing dangerous buildups, wherever they might arise. And the Office of Financial Research, formed within Treasury and equipped with subpoena power, was supposed to provide the FSOC with the data and analysis needed to do the job well.

This financial early warning system didn’t operate as intended. The FSOC’s efforts to impose special scrutiny on certain systemically important non-bank institutions, such as insurance companies, ran into legal and political headwinds. Its member agencies often proved reluctant to encroach on one another’s turf, and the FSOC lacked the power to compel action. The OFR never subpoenaed anything, for fear of making enemies. Ultimately, the Trump administration deemphasized and defunded the whole apparatus.

As a result, the U.S. was much less prepared for the shock of the pandemic than it could have been. A rush to cash triggered runs on certain money-market mutual funds, threatened the flow of credit to everyone from homebuyers to municipalities, and — in a troubling departure from the usual “flight to quality” — caused the prices of Treasury securities to fall sharply. The Treasury and the Federal Reserve had to go to extreme lengths and pledge trillions of dollars to restore stability.

Regulators’ objective should not be merely to put out fires once they see smoke, but to prevent the dangerous accumulation of combustible material. New threats will emerge in unexpected ways; solutions will prompt unanticipated responses. So regulation must be dynamic, requiring an ongoing assessment process, not just periodic changes. To meet that challenge, we urge a restructuring of the FSOC and the OFR.

  1. Congress should give each FSOC member agency an explicit financial stability mandate, and require each to establish a similarly focused office to inform its rule making. This would force agencies such as the Securities and Exchange Commission, the Commodities Futures Trading Commission, and the Consumer Financial Protection Bureau to consider systemic-risk issues that they can otherwise too often neglect.
  2. Only the Treasury Secretary should issue the FSOC’s annual report, avoiding the consensus-building process among member agencies that can weaken identification of risks and accountability for dealing with them. While each agency would write a separate appendix, the Secretary would bear ultimate responsibility. The report should include a look back at what risks were missed, why, and how they will be addressed. To ensure the subject gets adequate attention, a new under-secretary for financial stability should act as the secretary’s point person.
  3. The OFR should receive a clear new mandate to gather the data that policymakers need (and, today, often lack). To underscore its importance, it should be renamed the Comptroller for Data and Resilience — echoing the stature of the Comptroller of the Currency — and its head should have a voting seat at the FSOC, a level of authority that would help the government recruit talent and experience to the post.

As the pandemic begins to recede, concern over financial stability should not. We don’t know what major shock will next hit the economy and financial system. But a process to scan for risks and adapt to them should be front and center.

Glenn Is Interviewed by the Financial Times

The Financial Times recently interviewed Glenn. Here is an edited version. The full interview can be found here.

Financial Times (Gillian Tett, editor-at-large for the United States): Gross domestic product data show that the economy is rebounding very fast from the pandemic; the Federal Reserve just said that it doesn’t intend to raise rates any time soon; and President Joe Biden has pledged a massive fiscal package. So what is your forecast for the American economy?

Glenn:  Re-opening as the virus recedes would always lead to a very significant pop in GDP growth. So the near-term is not really the big question. There will certainly be a transitory increase in inflation. But I think the Fed on balance is correct, that boost is likely to be transitory. My worry is when I hear the Fed talk, as its chair Jay Powell has done, about wanting to watch for labor market “re-healing” to finish. The problem in the labor market is [largely] structural. Just running the economy hot by the Fed doesn’t fix that.

On fiscal policy, this is not just a “boost”.… The American Rescue Plan was intended as stimulus. But the American Jobs Act, the American Families Plan, those are really a remaking of the size of government. It has to be paid for and arithmetically can’t be paid for by taxes on the rich. There’s just not enough there. So the honest conversation with the American people is a matter of public choice: if you want a big government that does what President Biden wants [it to do], you’ll have to pay for it. 

GT: How confident are you that inflation pressures are transitory?

GH: One can never be completely confident, but I think if the Fed had a clearer policy story I could be confident that commodity price increases are transitory. What worries me is the Fed thinking it can lean against structural changes in the labor market with monetary policy. One might worry a bit about inflation risks in the long-term—some of the structural headwinds against inflation to do with demography and growth in the emerging world, particularly in China, are going away. 

GT: Do you think that the Fed should be indicating that it’s willing to raise rates if inflation rises?

GH: I think the Fed is unlikely to do that. [But] one of the reasons you are seeing implied volatility in rates and credit markets so high relative to equities, is the fear in the bond market that, maybe, the Fed is saying one thing but if backed into the corner could do another. Remember that the Fed bought around half of Treasury issues last year, and owns 40 per cent of all of the outstanding 10-year plus maturity treasuries, so the Fed’s thoughts there, which aren’t really clear to the bond market, are very, very important. 

GT: Larry Summers has said this is way too much [stimulus], way too fast and will create inflation risks. You and Larry don’t often agree, but would you agree on this? 

GH: I would agree on the risk, but it’s [not] the problem that is worrying me the most. What worries me even more is [in trying to] create a government that large . . .  if you want a government that does those things, tax burdens will have to be higher.

If you look at the math on the tax burden, the [proposed] corporate tax increase or capital gains tax increase are not remotely large enough. The other structural thing that worries me is that I do see productivity reductions and investment reductions as a result of these large tax increases. 

GT: Biden said if you are earning less than $400,000 a year you will not see your taxes go up. 

GH: Well, it’s just not true, [neither] in the near-term [nor] the long-term. Take the corporate tax. Many economists have concluded that much of the burden of the corporate tax is borne by workers. In the 1970s and early 1980s, we thought it was capital that bore the burden of the corporate taxes. [But] that is not what economists believe today. So you simply cannot say that people who make less than $400,000 aren’t going to bear a part of the burden of the tax. 

Likewise with capital gains, the president says: “I’m only going after 0.3 per cent of taxpayers,” meaning [those] that make more than a million dollars a year and have capital gains. But those individuals don’t have 0.3 per cent of the capital gains—they likely have the bulk of them. So if there are any effects on risk-taking, on saving and investment, the [risks] are very large.

Those effects are borne by the economy, not by the top 0.3 per cent …. And in the longer term … if you look at the budget math here, there’s going to be a large revenue hole. Somebody has to pay for it. 

GT: Well, what about that “somebody” being companies? 

GH: Let’s put the tax changes into two buckets. On the rates, I don’t think we want to go as high as the president is proposing, certainly not back to the old rates. On the base, president Biden is proposing a tax increase by base broadening—it’s a very, very big change. I expect companies will acknowledge they need to pay some minimum level, but the math isn’t going to add up.

GT: What about taxes under the guise of climate change action, such as a fuel tax or value added tax?

GH: I think it’s a great idea. For years I have supported a carbon tax because I do believe that it is one of the best ways to deal with climate change. I’m very skeptical of subsidies in green things but if you put a price on carbon, businesspeople will rush around and innovate and do it efficiently and it does not have to be regressive .…

About [a value-added tax] VAT—there is no question that if we want the government President Biden is suggesting, you absolutely have to have a VAT.

European states that have much bigger [state sectors] than the American state as a share of GDP are not financed with taxes on capital. In fact, in many European countries capital taxes are lower than they are in the United States. They’re financed by consumption taxes [such as the VAT]. 

GT: Why do you think Biden’s package is undermining productivity? 

GH: Let me just take one step back. Some discussions of secular stagnation come from insufficient aggregate demand. Another school of thought thinks that structurally we have a problem with productivity growth, in terms of the supply side of the economy and the economy’s potential to grow. That is where I’m coming from. The tax plans are definitely anti-investment, as the lack of capital deepening explains low productivity growth and capital gains tax increases can affect risk-taking. There’s certainly nothing to enhance productivity [in Biden’s plans] and a lot to discourage productivity. 

It is not just the tax policy. I worry about a monetary policy that could lead to zombification of firms—an environment of very low interest rates that sustain low-productivity firms. To President Biden’s credit, pieces of what he’s proposing that are true infrastructure could, in fact, raise productivity, but that is a small part of what he’s actually calling infrastructure. 

GT: Are you concerned about a future debt crisis?

GH: Well, we are the reserve currency country, and we are borrowing in our currency, so I think a slow and steady malaise is more likely. To give a practical example, the Medicare trust fund could run out of money within a year or so, social security within five or so years. That will force discussions in Washington as to whether the public may wish to have a government this size. 

GT: So you don’t expect a debt crisis per se because of the reserve currency status?

GH: [Not] at the moment.

GT: Should Republicans be co-operating to create a bipartisan bill? 

GH: You could get bipartisan support for a new “GI bill” to prepare workers to adjust from the Covid world. For example, support in community colleges.

I’m not talking about free community college but supply side support—increasing their capacity to train people. Where you won’t get bipartisan support is [for] the notion that we need to move away from a work-supported social insurance system to a broader cradle-to-grave safety net.

The administration really fuzzed that up by calling it an infrastructure bill. Infrastructure doesn’t have to be just roads and bridges and airports—it could be broadband. But not healthcare. 

GT: Are childcare support and elderly support part of “infrastructure”?

GH: No—those are social spending. 

GT: One of the interesting ways you frame this debate is with the contrast between Keynes and Hayek, i.e. whether you’re trying to prop up the current system or encourage more rapid transformation. What do you mean?

GH: You could think of Covid [in terms of] a Keynesian response — we have a collapse in demand. The Keynesian response is not fanciful. But Hayek would say the new world after Covid isn’t going to look like the old world, so why support every single business? Both are right. We did a good job in policy on the Keynesian part. [But] we’ve done less well [thinking about Hayek]. 

GT: What do you think about Larry Summer’s concept of secular stagnation? 

GH: There’s a scene in Dickens’ A Christmas Carol, when Scrooge asks, [something like] “are these the shadows of things that are or might be?”. I feel the same way about Bob Gordon’s descriptions of the American economy — Larry and Bob are talking about the shadows of things that could be if we have bad enough public policy, going back to the anti-productivity story. But I don’t think they’re inevitable. 

Every businessperson with whom I speak is pretty optimistic about the technology frontier in productivity. If there’s a reason for pessimism, it’s more about the political system’s ability and willingness to let that productivity growth [run free].

GT: Do you think that the Republican party knows what it stands for with economics?

GH: … [An] approach Republicans could take is to go past the neoliberalism to liberalism (with a small L), to Adam Smith. He was anti-mercantilist—that’s what got him angry in The Wealth of Nations—and he was very interested in the ability of everybody in the economy to compete.

So a new Republican agenda might do more to help people compete—that sounds more like Lincoln, or like Roosevelt’s GI bill. In that lies a new agenda. But I don’t see the party really moving in that direction. 

GT: What about the second book of Smith’s, The Theory of Moral Sentiments?

GH: Smith referred to “mutual sympathy”, which today we would call empathy. Forward-leaning businesspeople and business leaders think that way. I don’t see [the environmental, social, and governance] ESG [approach to investing] as somehow an enemy of shareholders—this isn’t Milton Friedman versus socialism—it’s more a matter of what really is in the long-term interest of the firm.

Remember, Smith railed against the British East India Company, which he thought of as a cancer. He thought you had to be very careful in the social framing of corporations. Businesspeople today need to understand the corporate structure is a social gift. In fact, capitalism is a social gift. If the public doesn’t want it, it won’t happen. 

GT: I have a book coming out in a few weeks’ time that stresses this social and cultural aspect of business and finance and economics, and argues that business leaders need to move beyond tunnel vision to use lateral vision. Do you agree with this? 

GH: Yes. When I teach students political economy, I remind them that great thinkers like a Friedman or Hayek or Smith wrote [for] the times in which they lived. Friedman and Hayek were writing in response to a very slovenly and inefficient corporatist economic system and were horrified by fascism. If Ronald Reagan were with us today, I don’t think he would be the 1980s Ronald Reagan. If Friedman and Hayek were with us today, they might have a different view. Context shifts.

GT: Friedman was also operating when people assumed that they could outsource the difficult social decisions to government and when there wasn’t radical transparency and customers, clients and employees couldn’t see exactly what firms were doing. Does that matter?

GH: Yes. If Friedman were here he might correctly remind us that there are big social externalities no one company can fix. But there is no reason businesspeople can’t be leaders. When the Marshall Plan was passed, that was not because Congress in its great wisdom decided to do something. It was because the business community came together and said: “Good Lord, we are going to have communism in western Europe and what’s that going to do to our economic system?” They pushed Congress. I understand that [today business is] afraid. But it’s not an excuse not to act. At many companies, their own employees are going to put pressure [on them to act]. 

GT: You are starting to see a level of company collaboration which was unimaginable when we had Thatcherism and Reaganism. Will this last? 

GH: I do [think so] and Hayek would have celebrated this co-ordinated response because it bubbled up from the bottom. If you compare the production of vaccines, which was largely a private-sector activity, to the distribution of vaccines, which was more a public-sector activity, I think we know which one seemed to work better.

There are things that could help that—imagine if Biden put applied research centers all around the country that were linked with universities. That might help companies fix localities, as well as solving big problems like vaccines. 

GT: Are you concerned that we have an ESG bubble?

GH: I am, in several aspects. We are running the risk of industrial policy and rent seeking, with just subsidizing “green things.” I also worry about how CEOs can deal with this—you don’t want the CEO spending half of his or her day responding to social concerns.

GT: What about protectionism? Can the Republicans present an alternative voice on this? 

GH: I hope so, but I’m not sure. Like almost all economists … I believe in free trade. So why is something that is obvious in Econ 101 not so popular with the public?

I think for two reasons. One is whenever your Econ 101 professor talked about the gains from trade, he or she always [had] the idea that there would be losers, but compensation would somehow occur—and it hasn’t.

[Second] free trade is one of those examples, like the old classical gold standard, of a system that’s outside-in. You have to sign up for the rules of the game and then you just adjust. I think we need to go back to a period that says, look, we do need to understand domestic constituencies. That could mean much more support for training, it could be wage insurance, it could be lots of things rather than just saying free trade. 

GT: So it’s about trying to talk about free trade with both parts of Adam Smith. 

GH: Yes, exactly. Even Smith, who was the champion for openness, would not have countenanced whole areas just being left behind. Smith talked a lot about places—he said something like a man is a sort of luggage that’s hard to move, meaning you really have to look after places, not just jobs . . . its culture. 

GT: Hey, anthropology can mingle with economics! 

GH: Exactly—two social sciences, peas in a pod. 

GT: So what’s happening to the economics profession? With issues like [the debate around Larry Summers’ criticism of Biden’s policies] are we seeing a tribal warfare break out between economists? Is there a rethink of economics? Is Biden moving away from them?

GH: Well, let me start with some good news: the young stars in the [economics] profession today tend to be people who are talking about big problems with new tools and techniques, ranging from development to monetary policy to labor markets. I think that’s entirely healthy. 

I think the government needs people who have big macro views [too]. If I were in Janet Yellen’s shoes, I’d want to be talking to economists who could continue to give me that perspective, but also get micro perspectives from labor and financial markets. So there needn’t be a war. [But] I do worry from the way the Biden administration is talking about policies that economists just aren’t very involved at all. That’s not the first administration I’ve seen that happen—but it is a concern for the economics profession. 

NEW! – 04/16/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss monetary policy and the tools available to the Federal Reserve.

Authors Glenn Hubbard and Tony O’Brien follow up on last week’s fiscal policy podcast by discussing monetary policy in today’s world. The Fed’s role has changed significantly since it was first introduced. They keep an eye on inflation and employment but aren’t clear on which is their priority. The tools and models used by economists even a decade ago seem outdated in a world where these concepts of a previous generation may be outdated. But, are they? LIsten to Glenn & Tony discuss these issues in some depth as we navigate our way through a difficult financial time.

Just search Hubbard O’Brien Economics on Apple iTunes or any other Podcast provider and subscribe! Today’s episode is appropriate for Principles of Economics and/or Money & Banking!

Please listen & share!

9/11/20 Podcast – Authors Glenn Hubbard & Tony O’Brien cover current events, Micro, and Macro! They discuss 9/11, the rising stock market, the challenges facing restaurants, as well as shifts in strategy for the Fed!

Authors Glenn Hubbard and Tony O’Brien continue their weekly discussion about the effects of the Pandemic on the US Economy. They discuss the disconnect between stock market performance and the overall economy. Also, they look at the decision of restaurants to stay open despite struggling to breakeven due to limitations on indoor seating. The Fed’s pivot on the dual-mandate is also discussed as they announce more of their monetary policy focus will be on unemployment rather than inflation.

Over the next several weeks, we will be gearing up this podcast to become an essential listen during your week. Whether your interest is teaching or policy, you will learn from this discussion.

Just search Hubbard O’Brien Economics on Apple iTunes and subscribe!

Please listen & share!

4/17/20 Podcast – Glenn Hubbard & Tony O’Brien discuss the Federal Reserve response and toilet paper shortages.

On April 17th, Glenn Hubbard and Tony O’Brien continued their podcast series by spending just under 30 minutes discuss varied topics such as the Federal Reserve’s monetary response, record unemployment numbers, panic buying of toilet paper as compared to bank runs, as well as recent books they’ve been reading with increased downtime from the pandemic.

4/9/20 – UNWRITTEN Pearson Webinar with Glenn Hubbard and Jaylen Brown, Pearson Campus Ambassador.

During the initial UNWRITTEN webinar from Pearson, Glenn Hubbard had a conversation with Jaylen Brown, a Pearson Campus Ambassador as well as a student at University of Central Florida -also Glenn’s undergrad alma mater!

Over the 30-minute broadcast, they discussed topics of relevance to all students – real world outlook on jobs, supply and demand, and the policies aimed at relief. Glenn talks of recovery shaped like a Nike swoosh with a sharp decline and a slightly longer climb back to normalcy. Check out the full episode now posted on YouTube!

4/10/20 Podcast – Glenn Hubbard & Tony O’Brien discuss the economic impacts of the pandemic.

On April 10th Glenn Hubbard and Tony O’Brien sat down together to discuss some of the larger impacts of the pandemic.

In these 18 minutes, Glenn and Tony discuss the fiscal & monetary response, the future relationship of the US Treasury and the Federal Reserve System, as well as several other topics.

COVID-19 Update: Monetary and Fiscal Policy Responses: The Great Recession vs. the Coronavirus Pandemic

Supports:  Hubbard/O’Brien, Economics, Chapter 25 – Monetary Policy (Macro Chapter 15 and Essentials Chapter 17), and Chapter 26 – Fiscal Policy (Macro Chapter 16 and Essentials Chapter 18).

The Great Recession of 2007-2009 was the worst economic contraction in the United States since the Great Depression of the 1930s.  Accordingly, it brought a vigorous response from federal policymakers.  As of late March 2020, it was too soon to tell how severe the economic contraction from the coronavirus pandemic might be.  But policymakers had already responded with major initiatives.  In the following sections, we compare monetary and fiscal policies employed during the Great Recession and those employed at the beginning of the coronavirus pandemic.

A Brief History of U.S. Recessions

             Historically, most recessions in the United States have been caused by one of two often related factors: (1) A financial crisis or (2) Federal Reserve actions taken to reduce the inflation rate.  The two main exceptions are the recession of 1973-1975, which was primarily the result of a sharp increase in oil prices, and the recession of 2020, which was the result of the effects of the coronavirus pandemic and of the business closures ordered by state and local governments in an attempt to contain the pandemic.

            Prior to 1914, the United States lacked both a central bank that could act as a lender of last resort to keep bank runs from escalating into bank panics and a system of deposit insurance.  By cutting off many businesses from their main source of credit and cutting off both households and firms from their bank deposits, bank panics resulted in declines in production and employment. The failure of the Federal Reserve to effectively deal with the waves of bank panics from 1930 to 1933 at the beginning of the Great Depression led Congress in 1934 to establish the Federal Deposit Insurance Corporation (FDIC) to insure deposits in commercial banks (currently up to $250,000 per depositor, per bank). The following table shows that prior to World War II (U.S. participation lasted from 1941 to 1945), most recessions were associated with bank panics.

 As a result of deposit insurance and more active Federal Reserve discount lending, after World War II problems in the commercial banking system were no longer a major source of instability in the U.S. economy.  As the following figure shows, declines in residential construction have preceded every recession in the United States since 1958 (the shaded areas represent periods of recession). Edward Leamer of the University of California, Los Angeles had gone so far as to argue that “housing is the business cycle.” Prior to the housing crash that preceded the Great Recession, the main cause of the declines in residential construction shown in the figure were rising mortgage interest rates, typically due to the Federal Reserve raising its target for the federal funds rate—the interest rate that banks charge each other on overnight loans—in response to increases in the inflation rate.


Monetary Policy during the Great Recession

Both the Great Recession of 2007-2009 and pre-World War II recessions were accompanied by financial panics.  Both the Great Recession of 2007-2009 and post-World War II recessions were accompanied by sharp downturns in the housing market.

But the Great Recession differed from earlier recessions two key ways:  First, it was caused by problems internal to the housing market rather than the effect on the housing market of contractionary monetary policy; and second, it did not involve commercial banks.  Instead, it involved the shadow banking sector of investment banks, money market mutual funds, and insurance companies. 

            Problems began in the market for mortgage-backed securities—bonds that consisted of mortgages bundled together. The value of the bonds depended on the value of the underlying mortgages. When housing prices began to decline in 2006, borrowers began defaulting on mortgages.  Many commercial and investment banks owned these mortgage-backed securities, so the decline in the value of the securities caused these banks to suffer heavy losses. By mid-2007, investors and policymakers became concerned about the decline in the value of mortgage-backed securities and the large losses suffered by commercial and investment banks. Many investors refused to buy mortgage-backed securities, and some investors would buy only bonds issued by the U.S. Treasury.

            The problems in financial markets resulting from the bursting of the housing bubble were severe, particularly after the failure of the Lehman Brothers investment bank in September 2008.  In previous recessions, the focus of the Fed’s expansionary policy had been on cutting its target for the federal funds rate to reduce borrowing costs and spur spending, particularly spending on residential construction.  The Fed did rapidly cut its target for the federal funds rate from 5.25 percent in September 2007 to effectively 0 percent in December 2008. But the financial crisis reduced the effect of these rate cuts because the flow of funds through the financial system had largely dried up.  As a result, the Fed entered into an unusual partnership with the U.S. Treasury Department and intervened in financial markets in unprecedented ways, which we summarize in the following table. In addition to the actions shown in the table, for the first time since the 1930s, the Fed bought commercial paper—short-term bonds issued by corporations—because many firms found their usual sources of funds were no longer available in the crisis. The Fed’s aim was to restore the flow of funds through the financial system to enable firms to obtain the credit they needed to maintain production and employment.


Fiscal Policy during the Great Recession

Presidents George W. Bush and Barack Obama both initiated fiscal policy responses to the Great Recession. In 2008, President Bush and Congress enacted a tax cut that took the form of rebates of taxes had already paid. After taking office in January 2009, President Obama and Congress enacted the $840 billion American Recovery and Reinvestment Act (AARA), often called the “stimulus package.”  The following figure summarizes the spending and tax cuts in the ARRA.

During the Great Recession, the Fed’s monetary policy moved well beyond its usual focus on targeting the federal funds rate. But fiscal policy was more conventional: Increasing government spending and cutting taxes to increase aggregate demand, real GDP, and employment. The ARRA was notable mainly because of its size.

Monetary Policy in Response to the Coronavirus Epidemic

            During 2019, prior to the epidemic beginning to affect the United States, the Fed had twice cut its target for the federal funds rate in response to a slowing rate of economic growth.  With the spread of the coronavirus at the start of 2020, the Fed again cut its target twice, returning it effectively to 0 percent in mid-March.  With many businesses closed and many consumers largely confined to their homes, the Fed knew that lower borrowing costs would not be the key to maintaining economic activity.  Accordingly, the Fed revived some of the lending facilities that it had used during the 2007-2009 financial crisis and set up some new facilities with the goal of maintaining the flow of funds through the financial system and the ability of firms whose revenues had plunged to continue to access credit.

            Here is a summary of Fed’s policy actions during March and early April 2020:

  • Cuts to the Federal Funds Rate  The Fed reduced its target for the federal funds rate from a range of 1.75 percent to 1.50 percent to a range of 0 percent to 0.25 percent.
  • Purchases of Mortgage-Backed Securities  To provide funds to the market for mortgage lending, the Fed began purchasing mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae, which are government-sponsored enterprises (GSEs).
  • Central Bank Liquidity Swap Lines  To meet a surge in demand by foreign businesses and governments for U.S. dollars, the Fed expanded its Central Bank Liquidity Swap Lines, which allow foreign central banks to exchange their currencies for dollars.
  • Facility for Foreign and International Monetary Authorities  To further help foreign central banks meet the demand for U.S. dollars by foreign businesses and governments, the Fed established the Foreign and International Monetary Authorities repurchase agreement facility, which allowed these authorities to “temporarily exchange their U.S. Treasury securities held with the Federal Reserve for U.S. dollars, which can then be made available to institutions in their jurisdictions.” This new facility reduced the need for foreign central banks to sell U.S. Treasury securities to obtain U.S. dollars. Those sales had been contributing to volatility in the market for U.S. Treasury securities.
  • Primary Dealer Credit Facility  To ensure the liquidity of the 24 primary dealers, which are the large financial firms who interact with the Fed in securities markets, the Fed established the Primary Dealer Credit Facility to provide loans to these dealers.
  • Commercial Paper Funding Facility  To ensure that corporations would have access to short-term funds necessary to meet payrolls and pay their suppliers, the Fed established the Commercial Paper Funding Facility to buy commercial paper from corporations.
  • Primary Market Corporate Credit Facility  To ensure that corporations have access to longer-term funds, the Fed established the Primary Market Corporate Credit Facility to make loans to corporations whose bonds are rated investment grade by Moody’s, S&P, and Fitch, the private bond rating agencies.
  • Secondary Market Corporate Credit Facility  To ensure the smooth functioning of the corporate bond market, the Fed established the Secondary Market Corporate Credit Facility to buy in the secondary market investment grade bonds issued by corporations and to buy shares in exchange-traded funds that are primarily invested in such bonds. First established in March, the facility was expanded in April to allow for the purchase of some non-investment grade corporate bonds and the purchase of shares in exchange-traded funds that are invested in such bonds.
  • Term Asset-Backed Securities Loan Facility (TALF) To support the flow of credit to consumers and businesses, the Fed began buying asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA).
  • Municipal Liquidity Facility To support the ability of state, county, and city governments to borrow, the Fed began buying short-term state and local bonds.
  • Main Street New Loan Facility (MSNLF) and Main Street Expanded Loan Facility (MSELF) To ensure that small and medium size businesses had the financial resources to survive the crisis, the Fed offered 4-year loans to companies employing up to 10,000 workers or with revenues of less than $2.5 billion. Principal and interest payments were deferred for one year. The facility was intended to augment the Paycheck Protection Programs, which was part of the CARES act and involves loans administered through the federal government’s Small Business Administration to firms with 500 or fewer employees.

In taking these actions, the Fed relied on its authority under Section 13(3) of the Federal Reserve Act, which authorizes the Fed under “unusual and exigent circumstances” to lend broadly.  Following the 2007-2009 financial crisis, Congress amended the Federal Reserve Act to require that the Fed receive the prior approval for such actions from the Secretary of the Treasury. After consultation with Fed Chair Jerome Powell, Treasury Secretary Steven Munchin provided the required approval.  As in the 2007-2009 financial crisis, the Fed was again conducting monetary policy in collaboration with the U.S. Treasury, rather than operating independently, as it had prior to 2007.

It remains to be seen whether these extraordinary actions will be sufficient to keep funds flowing through the financial system and to provide sufficient credit to allow businesses whose revenues had plunged to remain solvent. 

Fiscal Policy in Response to the Coronavirus Epidemic

            During the week of March 15, 2020, more than 3 million workers applied for federal unemployment benefits—five times more than had ever previously applied during a single week.  Congress and President Donald Trump responded to the crisis by passing three aid packages by the end of March 2020, with the likelihood that further aid packages would be passed during the following weeks.

            Unlike with fiscal policy actions during previous recessions, including the ARRA passed during the Great Recession, the main goal of these aid packages was not to directly stimulate aggregate demand by increasing government spending and cutting taxes. With many businesses closed and people in some states being asked to “shelter in place” or stay home except for essential trips such as buying groceries, a stimulus package of the conventional type was unlikely to be effective. Congress and the president instead focused on (1) helping businesses to remain open after many had experienced enormous declines in revenue and (2) providing households with sufficient funds to pay their rent or mortgage, buy groceries, and cover other essential spending.

Here is a summary of Congress and the president’s first three fiscal policy actions:

  • Research Funding and Aid to State and Local Governments In early March, Congress and the president passed an $8.3 billion bill to provide funds for research into a vaccine for the coronavirus and for state and local governments to help cover some of their costs in fighting the virus.
  • Increases in Benefits and Tax Credits  In mid-March, Congress and the president passed a $100 billion bill aimed at increasing unemployment benefits, increasing benefits under the Supplemental Nutrition Assistance Program ( also called food stamps), and providing tax credits to firms offering paid sick leave to employees.
  • Coronavirus Aid, Relief and Economic Security (CARES) Act  On March 27, Congress and the president passed the Coronavirus Aid, Relief and Economic Security (CARES) Act, a more than $2 trillion aid package—by far the largest fiscal policy action in U.S. history—to provide:
    • Direct payments to households
    • Supplemental unemployment insurance payments
    • Funds to state governments to offset some of their costs in fighting in the epidemic
    • Loans and grants to businesses

The macroeconomic policy actions undertaken by the Fed, Congress, and the president in the spring of 2020 were unprecedented in size and scope. Whether they would be effective in keeping the coronavirus epidemic from causing a major recession in the United States remains to be seen.

Note: Some of the figures and tables reproduced here were first published in Hubbard and O’Brien, Economics, 6th and 8th editions or Hubbard and O’Brien, Money, Banking, and Financial Markets, 3rd edition.

Sources: Federal Reserve Bank of New York, “New York Fed Actions Related to COVID-19,”; Board of Governors of the Federal Reserve System, “Text of the Federal Reserve Act: Section 13. Powers of Federal Reserve Banks,”, February 13, 2017; Nick Timiraos, “Fed Cuts Rates to Near Zero and Will Relaunch Bond-Buying Program,” Wall Street Journal, March 26, 2020; Eric Morath, Jon Hilsenrath and Sarah Chaney, “Record Rise in Unemployment Claims Halts Historic Run of Job Growth,” Wall Street Journal, March 18, 2020; Emily Cochrane, “House Passes $8.3 Billion Emergency Coronavirus Response Bill,” New York Times, March 9, 2020; and John Harney, “Here’s What’s in the $2 Trillion Virus Stimulus Package,”, March 25, 2020.


1. There are both similarities and differences between monetary policies employed during the Great Recession of 2007-2009 and those employed at the beginning of the coronavirus pandemic in 2020.

(a) How has the Fed attempted to stimulate the economy during a typical recession? 

(b) Briefly discuss ways in which the Fed’s approach during the Great Recession and during the coronavirus pandemic was similar.

(c) Briefly discuss ways in which the Fed’s approach during the Great Recession and during the coronavirus pandemic differed.

2.  There are both similarities and differences between fiscal policies employed during the Great Recession of 2007 – 2009 and those employed at the beginning of the coronavirus pandemic of 2020.

(a) How have Congress and the president attempted to stimulate the economy during a typical recession?

(b) Briefly discuss ways in which Congress and the president’s approach during the Great Recession and during the coronavirus pandemic was similar to traditional expansionary policy.

(c) Briefly discuss how Congress and the president’s approach during the Great Recession and during the coronavirus pandemic differed from traditional expansionary policy.

Instructors can access the answers to these questions by emailing Pearson at and stating your name, affiliation, school email address, course number.