FEDERAL-FUNDS-RATE TARGET: 0.0% to 0.25%
The coronavirus outbreak prompted dramatic action by the Federal Reserve this week. Not only did they cancel the regularly scheduled March 17-18 Federal Open Market Committee (FOMC) meeting, but they took several steps in advance of those dates to address the economic impact of the COVID-19 pandemic.
The Fed is determined to demonstrate that it will do everything it can in the face of this crisis. The problem is, its ability to help is limited under the circumstances.
The Unique Challenges of COVID-19
The health threat posed by COVID-19 is unlike anything the world has faced since the outbreak of Spanish influenza about a hundred years ago. The economic fallout may also pose once-in-a-century challenges.
Recession fears started cropping up last year. Now it appears likely that shutting down many parts of everyday economic activity will tip the economy over the edge.
The government normally responds to a slowing economy by using various tools to encourage people to continue spending their money. However, when many businesses are shut down and people are staying home due to health concerns, it's difficult for financial incentives to have much of an impact.
In addition, the monetary and fiscal tools used to revive the economy generally assume inflation isn't a problem - and it hasn't been an issue in recent years. However, as shortages of goods and services develop and start increasing as a result of the health crisis, inflation may be inevitable.
Rate Cuts, Quantitative Easing and More
So what is the FOMC doing in the face of this extreme challenge?
The Fed has announced a series of measures, including:
- Cutting interest rates to a target range of 0% to 0.25%
- Unleashing a new wave of quantitative easing, including purchases of $500 billion in Treasury securities and $200 billion in mortgage-backed securities
- Setting up special credit facilities for lenders and issuers of commercial paper to help make sure credit remains available to businesses and consumers
In addition to these monetary policy moves by the FOMC, the federal government is pursuing a variety of fiscal moves to prime the economic pump.
The first of these fiscal measures was an $8.3 billion emergency spending package to help fight the spread of the coronavirus. A far larger aid package, putting money directly in the hands of consumers and businesses, is now being considered.
What the Fed Hopes to Accomplish
The economic threat of pandemic comes in many forms, so there's a variety of goals behind the Fed's moves:
- Encourage continued borrowing
Lower interest rates make it cheaper to spend on credit (and cheaper to manage some existing debt). The idea is to help consumers afford to pay their bills and keep spending enough to support the economy.
- Provide liquidity to the financial system
A chain-reaction of credit problems is a big danger in situations like this.
Think of the various levels of the financial system this way: A lends to B, who lends to C, who lends to D. If D can't pay their debt, then C can't afford to pay what they owe to B, who defaults on what they owe to A. In this way, one default can lead to many defaults.
By easing access to credit, the Fed hopes to head off those default chain reactions.
- Give confidence to the financial markets
When stock market declines destroy wealth and dry up new investment, it worsens the immediate impact of shutting down part of the economy. The Fed hopes that, by taking dramatic actions now, it can get people to think past the immediate crisis and invest in the future.
But aside from the unique challenges of the COVID-19 outbreak, it will be even harder to achieve these goals given conditions heading into the crisis:
- Near-zero interest rates
Despite more than a decade of economic expansion, the Fed kept interest rates near zero, leaving it little room to cut rates in the face of a new financial crisis.
- Massive annual deficits
As for fiscal policy, the government's ability to prime the pump with spending would be much greater if it weren't already running massive annual deficits.
- High stock market valuations
Finally, stock market valuations were precariously high earlier this year, so it only took a catalyst for that risk to become reality.
How Consumers Can Help Themselves
Since there will be no easy solutions coming from the government, consumers should take their own steps to protect their finances. Here are some suggestions:
- Go on an emergency budget now
Don't wait for reserves to run low to start tightening your belt.
This healthcare crisis may go on for months, and the economic damage may last even longer. Cut spending now to make your resources last longer.
It may be easier to do this now, given that there are fewer ways to spend money with much of the country hunkered down.
- Think carefully about borrowing decisions
Lower interest rates make it cheaper to borrow, but consider what a recession might do to your ability to repay a loan. If you think your job may be at risk, this is a bad time to borrow.
- Make separate decisions about short-term and long-term assets
People are panicking out of the stock market. While it's understandable to make sure you have money available for your short-term needs, that shouldn't impact your long-term investments.
Secure what you need to ride out the current crisis, but think past that crisis when deciding what to do with your other assets.
- Look for opportunities to raise rates on your savings in a falling rate environment
Rates on savings, CDs and other deposit accounts are already tumbling.
Still, there remains such a big gap between the top rates offered by a handful of leading banks and the industry average that most bank customers could still raise the rate they earn even as rates overall are falling.
One of the words most used to describe the COVID-19 outbreak these days is "unprecedented."
That may be an accurate description, but it is important to remember that the economy has survived previous crises that came in sweeping and unexpected forms.
Economically, this pandemic's impact may have some similarities to the 1970s oil embargo, the 9/11 attacks and the Great Recession. Despite the hardships caused by those crises, in each case, the economy and the nation went on to see better days.
Previous Federal Reserve Board Updates articles:
|FOMC Date||2020 FOMC Meeting Update Articles|
|01/30/2020||Fed Rate Decision Means Consumers Have a Choice|