Fed Chair Powell, in a speech to the Peterson Institute for International Economics, described the severity of the sharp economic contraction, warned of the possibility of a weak recovery, low productivity growth and stagnant incomes, and highlighted the aggressive measures the Fed has taken so far. 

 

Powell reiterated that the FOMC will continue to utilize its monetary policy and lender of last resort tools fully until the crisis has passed. He also emphasized that more fiscal initiatives may be necessary, noting that, “Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery. This tradeoff is one for our elected representatives, who wield powers of taxation and spending.”

 

But while saying that the Fed will use all of the tools available at its disposal, in response to a question about negative policy rates, Powell was clear: “The Committee’s view on negative rates has not changed. This is not something we are looking at.” Powell noted that the Fed’s perspective is that evidence on the effectiveness of negative rates is mixed and it is concerned that negative rates may affect the intermediation process.

 

In a sense, this highlights the Fed’s dilemma. The Fed pledges to do everything possible to battle the economic and financial effects of the pandemic, but it fully understands that it is limited in its ability to address an extremely complex health crisis, and it is highly uncertain about the efficacy of the policy tools it has at its disposal to address the issues at hand. 

 

So far, it has reduced its Fed funds rate to close to 0%. It has infused massive amounts of liquidity into short-term funding markets to address dysfunctional markets and help avoid financial crisis. It has engaged in direct lending and support to businesses and other supports to the flows of credit to businesses, households, and state and local governments, lender of last resort functions permitted through its Section 13 (3) powers. On the monetary policy front, it has engaged in large-scale asset purchases of Treasuries and MBS. 

 

But the Fed now admits that its aggressive QE asset purchases after the economy had recovered from the financial crisis of 2008-2009 did not work nearly as well as it had earlier asserted. QEII and QEIII did not lower rates materially, and the Fed’s stimulus to the stock market and risk-taking did not generate an acceleration in growth or business investment. So taking negative rates off the table when rates are zero and the efficacy of QE is questionable is constraining. 

 

The ECB’s and BoJ’s experience with negative policy rates—especially keeping them in place for an elongated period—has certainly raised a number of concerns about their efficacy and unintended side effects. But the effectiveness of the Fed’s QE programs can also be questioned, and they have also involved unintended consequences, including accentuating wealth inequality, and generating excessive financial risk-taking. 

 

So where does the Fed stand? It is wise to take Chair Powell at face value: amid extraordinarily difficult circumstances, the Fed will take whatever steps it perceives as necessary to avoid financial crisis and help the economy recover, but it is truly limited. Chair Powell announced that the Fed’s Main Street Lending Facility (will offer loans to small and mid-sized businesses that were in good financial standing before the crisis) will officially launch in a few weeks. Yesterday, the Fed’s Secondary Market Corporate Credit Facility began purchases of corporate bond ETFs. Clearly, the Fed is digging deep into its lender of last resort capabilities that under normal conditions would be rejected out of hand. Presently, the Fed is not considering imposing negative policy rates. But the situation is fluid and anything is possible. 

 

Mickey Levy, mickey.levy@berenberg-us.com

Roiana Reid, roiana.reid@berenberg-us.com

 



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