To Decrease the Money Supply, What Could the Federal Reserve Do?

Editor'south Note:

Jeffrey Cheng, Tyler Powell, and David Skidmore contributed to earlier versions of this post.

The coronavirus crisis in the United States—and the associated business closures, result cancellations, and work-from-home policies—triggered a deep economic downturn. The abrupt contraction and deep uncertainty about the course of the virus and economic system sparked a "dash for greenbacks"—a desire to hold deposits and only the most liquid assets—that disrupted financial markets and threatened to brand a dire situation much worse. The Federal Reserve stepped in with a wide array of actions to go along credit flowing to limit the economical harm from the pandemic. These included large purchases of U.S. government and mortgage-backed securities and lending to back up households, employers, financial market participants, and country and local governments. "We are deploying these lending powers to an unprecedented extent [and] … will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery," Jerome Powell, chair of the Federal Reserve Board of Governors, said in April 2020. In that same month, Powell discussed the Fed's goals during a webinar at the Brookings' Hutchins Center on Financial and Budgetary Policy. This mail summarizes the Fed's actions though the finish of 2021.

HOW DID THE FED SUPPORT THE U.S. ECONOMY AND FINANCIAL MARKETS?

Easing Monetary Policy

• Federal funds charge per unit: The Fed cut its target for the federal funds rate, the charge per unit banks pay to borrow from each other overnight, by a total of one.5 percentage points at its meetings on March 3 and March 15, 2020. These cuts lowered the funds rate to a range of 0% to 0.25%. The federal funds charge per unit is a criterion for other short-term rates, and also affects longer-term rates, so this move was aimed at supporting spending by lowering the cost of borrowing for households and businesses.
• Forward guidance: Using a tool honed during the Great Recession of 2007-09, the Fed offered forward guidance on the hereafter path of interest rates. Initially, it said that it would keep rates about zero "until information technology is confident that the economy has weathered recent events and is on runway to achieve its maximum employment and price stability goals." In September 2020, reflecting the Fed's new monetary policy framework, it strengthened that guidance, proverb that rates would remain depression "until labor market conditions accept reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 pct and is on track to moderately exceed ii pct for some fourth dimension." Past the finish of 2021, aggrandizement was well in a higher place the Fed's two% target and labor markets were nearing the Fed's "maximum employment" target. At its Dec 2021 meeting, the Fed's policy-making committee, the Federal Open Market Committee (FOMC), signaled that well-nigh of its members expected to raise interest rates in iii one-quarter percent bespeak moves in 2022.
• Quantitative easing (QE): The Fed resumed purchasing massive amounts of debt securities, a key tool it employed during the Great Recession. Responding to the astute dysfunction of the Treasury and mortgage-backed securities (MBS) markets after the outbreak of COVID-19, the Fed's actions initially aimed to restore smooth functioning to these markets, which play a critical role in the flow of credit to the broader economic system as benchmarks and sources of liquidity. On March fifteen, 2020, the Fed shifted the objective of QE to supporting the economy. It said that information technology would purchase at to the lowest degree $500 billion in Treasury securities and $200 billion in regime-guaranteed mortgage-backed securities over "the coming months." On March 23, 2020, it fabricated the purchases open-ended, saying it would buy securities "in the amounts needed to support shine market functioning and effective transmission of monetary policy to broader financial conditions," expanding the stated purpose of the bail buying to include bolstering the economy. In June 2020, the Fed set up its rate of purchases to at least $fourscore billion a month in Treasuries and $40 billion in residential and commercial mortgage-backed securities until further notice. The Fed updated its guidance in December 2020 to indicate information technology would slow these purchases in one case the economic system had made "substantial further progress" toward the Fed'southward goals of maximum employment and cost stability. In November 2021, judging that test had been met, the Fed began tapering its stride of asset purchases by $10 billion in Treasuries and $v billion in MBS each calendar month. At the subsequent FOMC meeting in December 2021, the Fed doubled its speed of tapering, reducing its bail purchases past $20 billion in Treasuries and $x billion in MBS each month.

Supporting Fiscal Markets

• Lending to securities firms: Through the Primary Dealer Credit Facility (PDCF), a program revived from the global financial crisis, the Fed offered depression interest charge per unit loans upwardly to 90 days to 24 large fiscal institutions known as chief dealers. The dealers provided the Fed with various securities equally collateral, including commercial newspaper and municipal bonds. The goal was to help these dealers go along to play their role in keeping credit markets functioning during a time of stress. Early in the pandemic, institutions and individuals were inclined to avoid risky assets and hoard cash, and dealers encountered barriers to financing the rising inventories of securities they accumulated every bit they made markets. To re-establish the PDCF, the Fed had to obtain the approval of the Treasury Secretary to invoke its emergency lending authorisation under Section 13(3) of the Federal Reserve Human activity for the showtime time since the 2007-09 crisis. The program expired on March 31, 2021.
• Backstopping coin market mutual funds: The Fed as well re-launched the crisis-era Money Market place Common Fund Liquidity Facility (MMLF). This facility lent to banks against collateral they purchased from prime number coin market funds, which invest in Treasury securities and corporate curt-term IOUs known as commercial paper. At the onset of COVID-19, investors, questioning the value of the private securities these funds held, withdrew from prime money marketplace funds en masse. To meet these outflows, funds attempted to sell their securities, but market disruptions made it difficult to find buyers for even high-quality and shorter-maturity securities. These attempts to sell the securities only drove prices lower (in a "fire sale") and closed off markets that businesses rely on to raise funds. In response, the Fed ready the MMLF to "assist coin market funds in coming together demands for redemptions by households and other investors, enhancing overall market functioning and credit provision to the broader economy." The Fed invoked Department 13(3) and obtained permission to administer the program from Treasury, which provided $10 billion from its Exchange Stabilization Fund to cover potential losses. Given limited usage, the MMLF expired on March 31, 2021.
• Repo operations: The Fed vastly expanded the scope of its repurchase agreement (repo) operations to funnel cash to money markets. The repo marketplace is where firms infringe and lend cash and securities short-term, commonly overnight. Since disruptions in the repo market can affect the federal funds rate, the Fed's repo operations made cash bachelor to chief dealers in substitution for Treasury and other authorities-backed securities. Before coronavirus turmoil hit the market, the Fed was offering $100 billion in overnight repo and $20 billion in two-calendar week repo. Throughout the pandemic, the Fed significantly expanded the programme—both in the amounts offered and the length of the loans. In July 2021, the Fed established a permanent Standing Repo Facility to backstop coin markets during times of stress.
• Foreign and International Monetary Authorities (FIMA) Repo Facility: Sales of U.Southward. Treasury securities by foreigners who wanted dollars added to strains in money markets. To ensure foreigners had access to dollar funding without selling Treasuries in the market, the Fed in July 2021 established a new repo facility called FIMA that offers dollar funding to the considerable number of foreign central banks that do not have established bandy lines with the Fed. The Fed makes overnight dollar loans to these cardinal banks, taking Treasury securities every bit collateral. The central banks can and so lend dollars to their domestic financial institutions.
• International swap lines: Using another tool that was of import during the global fiscal crisis, the Fed made U.S. dollars bachelor to foreign central banks to improve the liquidity of global dollar funding markets and to assistance those authorities support their domestic banks who needed to raise dollar funding. In exchange, the Fed received foreign currencies and charged interest on the swaps. For the five central banks that have permanent swap lines with the Fed—Canada, England, the Eurozone, Nippon, and Switzerland—the Fed lowered its interest rate and extended the maturity of the swaps. It too provided temporary swap lines to the central banks of Australia, Brazil, Denmark, Mexico, New Zealand, Norway, Singapore, South Korea, and Sweden. In June 2021, the Fed extended these temporary swaps until December 31, 2021.

Encouraging Banks to Lend

• Direct lending to banks: The Fed lowered the rate that it charges banks for loans from its discount window by 2 per centum points, from two.25% to 0.25%, lower than during the Cracking Recession. These loans are typically overnight—pregnant that they are taken out at the terminate of i twenty-four hours and repaid the following morning—but the Fed extended the terms to ninety days. At the disbelieve window, banks pledge a wide diverseness of collateral (securities, loans, etc.) to the Fed in substitution for cash, and so the Fed takes little (or no) risk in making these loans. The cash allows banks to go along functioning, since depositors can continue to withdraw coin and the banks tin make new loans. However, banks are sometimes reluctant to borrow from the discount window because they fear that if word leaks out, markets and others will think they are in problem. To counter this stigma, 8 large banks agreed to borrow from the discount window in March 2020.
• Temporarily relaxing regulatory requirements: The Fed encouraged banks—both the largest banks and community banks—to dip into their regulatory capital and liquidity buffers to increase lending during the pandemic. Reforms instituted later on the financial crisis require banks to concur additional loss-absorbing capital to prevent future failures and bailouts. However, these reforms also include provisions that allow banks to use their capital buffers to support lending in downturns. The Fed supported this lending through a technical modify to its TLAC (total loss-absorbing capacity) requirement—which includes majuscule and long-term debt—to gradually phase in restrictions associated with shortfalls in TLAC. (To preserve capital letter, big banks likewise suspended buybacks of their shares.) The Fed also eliminated banks' reserve requirement—the percent of deposits that banks must hold equally reserves to meet greenbacks demand—though this was largely irrelevant because banks held far more than the required reserves. The Fed restricted dividends and share buybacks of bank belongings companies throughout the pandemic, but lifted these restrictions effective June 30, 2021, for most firms based on stress test results. These stress tests showed that banks had ample capital to back up lending even if the economy performed far weaker than predictable.

Supporting Corporations and Businesses

• Directly lending to major corporate employers: In a meaning step beyond its crisis-era programs, which focused primarily on financial marketplace operation, the Fed established 2 new facilities to support the menstruation of credit to U.S. corporations on March 23, 2020. The Primary Market Corporate Credit Facility (PMCCF) allowed the Fed to lend straight to corporations by ownership new bond issues and providing loans. Borrowers could defer interest and principal payments for at least the showtime six months so that they had cash to pay employees and suppliers (but they could non pay dividends or buy dorsum stock). And, nether the new Secondary Market place Corporate Credit Facility (SMCCF), the Fed could buy existing corporate bonds as well as commutation-traded funds investing in investment-form corporate bonds. An orderly secondary market was seen as helping businesses access new credit in the primary market place. These facilities allowed "companies access to credit and so that they are better able to maintain business operations and capacity during the flow of dislocations related to the pandemic," the Fed said. Initially supporting $100 billion in new financing, the Fed announced on April 9, 2020, that the facilities would be increased to backstop a combined $750 billion of corporate debt. And, as with previous facilities, the Fed invoked Section 13(3) of the Federal Reserve Human action and received permission from the U.S. Treasury, which provided $75 billion from its Exchange Stabilization Fund to embrace potential losses. Late in 2020, after the recovery from the pandemic was under style, and despite the Fed'due south misgivings, Treasury Secretarial assistant Steven Mnuchin decided that the final bond and loan purchases for the corporate credit facilities would take place no later than December 31, 2020. The Fed objected to the cutoff, preferring to go along the facilities available until there was a firmer assurance that financial conditions would not deteriorate again. The Fed said on June 2, 2021 that it would gradually sell off its $13.7 billion portfolio of corporate bonds, which it completed in Dec 2021.
• Commercial Newspaper Funding Facility (CPFF): Commercial paper is a $1.2 trillion market in which firms outcome unsecured brusk-term debt to finance their mean solar day-to-day operations. Through the CPFF, another reinstated crisis-era programme, the Fed bought commercial paper, essentially lending directly to corporations for up to 3 months at a rate 1 to two per centum points higher than overnight lending rates. "Past eliminating much of the risk that eligible issuers will non be able to repay investors by rolling over their maturing commercial newspaper obligations, this facility should encourage investors to once again appoint in term lending in the commercial paper market," the Fed said. "An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak." As with other not-bank lending facilities, the Fed invoked Section xiii(3) and received permission from the U.S. Treasury, which put $ten billion into the CPFF to cover any losses. The Commercial Paper Funding Facility lapsed on March 31, 2021.
• Supporting loans to small- and mid-sized businesses: The Fed'southward Principal Street Lending Program, announced on April 9, 2020, aimed to support businesses too large for the Small Business Administration's Paycheck Protection Program (PPP) and too small for the Fed'southward two corporate credit facilities. The program was subsequently expanded and broadened to include more potential borrowers. Through iii facilities—the New Loans Facility, Expanded Loans Facility, and Priority Loans Facility—the Fed was prepared to fund up to $600 billion in 5-year loans. Businesses with up to 15,000 employees or up to $5 billion in annual revenue could participate. In June 2020, the Fed lowered the minimum loan size for New Loans and Priority Loans, increased the maximum for all facilities, and extended the repayment period. As with other facilities, the Fed invoked Department 13(3) and received permission from the U.S. Treasury, which through the CARES Act put $75 billion into the three Main Street Programs to cover losses. Borrowers are subject to restrictions on stock buybacks, dividends, and executive compensation. (See here for boosted operational details.) Secretarial assistant Mnuchin, again over the Fed'south objections, decided that the Principal Street facility would stop taking loan submissions on Dec 14, 2020, equally it was gear up to make its final purchases by Jan 8, 2021. The Fed besides established a Paycheck Protection Program Liquidity Facility that facilitated loans made under the PPP. Banks lending to pocket-size businesses could borrow from the facility using PPP loans as collateral. The PPP Liquidity Facility closed on July xxx, 2021.
• Supporting loans to non-profit institutions: In July 2020, the Fed expanded the Principal Street Lending Program to non-profits, including hospitals, schools, and social service organizations that were in sound financial status before the pandemic. Borrowers needed at least ten employees and endowments of no more than $3 billion, amongst other eligibility weather condition. The loans were for 5 years, but payment of main was deferred for the showtime two years. As with loans to businesses, lenders retained five percent of the loans. This addition to the Master Street program lapsed with the residue of the facility on January 8, 2021.

Supporting Households and Consumers

• Term Asset-Backed Securities Loan Facility (TALF): Through this facility, reestablished on March 23, 2020, the Fed supported households, consumers, and pocket-sized businesses by lending to holders of asset-backed securities collateralized past new loans. These loans included student loans, automobile loans, credit card loans, and loans guaranteed by the SBA. In a footstep across the crunch-era program, the Fed expanded eligible collateral to include existing commercial mortgage-backed securities and newly issued collateralized loan obligations of the highest quality. Like the programs supporting corporate lending, the Fed said the TALF would initially support up to $100 billion in new credit. To restart it, the Fed invoked Section thirteen(3) and received permission from the Treasury, which allocated $ten billion from the Exchange Stabilization Fund to finance the program. Without an extension, this facility stopped making purchases on December 31, 2020, at Secretary Mnuchin's social club.

Supporting Land and Municipal Borrowing

• Straight lending to state and municipal governments: During the 2007-09 fiscal crunch, the Fed resisted backstopping municipal and state borrowing, seeing that as the responsibleness of the administration and Congress. But in this crisis, the Fed lent direct to land and local governments through the Municipal Liquidity Facility, which was created on April 9, 2020. The Fed expanded the list of eligible borrowers on April 27 and June three, 2020. The municipal bail market place was under enormous stress in March 2020, and state and municipal governments found it increasingly hard to infringe as they battled COVID-19. The Fed's facility offered loans to U.S. states, including the District of Columbia, counties with at least 500,000 residents, and cities with at least 250,000 residents. Through the programme, the Fed fabricated $500 billion bachelor to government entities that had investment-grade credit ratings as of April 8, 2020, in exchange for notes tied to future tax revenues with maturities of less than three years. In June 2020, Illinois became the starting time government entity to tap the facility. Under changes appear that calendar month, the Fed allowed governors in states with cities and counties that did not run into the population threshold to designate up to two localities to participate. Governors were too able to designate ii revenue bail issuers—airports, toll facilities, utilities, public transit—to be eligible. The New York Metropolitan Transportation Authority (MTA) took reward of this provision in Baronial, borrowing $451 1000000 from the facility. The Fed invoked Department thirteen(3) with the blessing of the U.S. Treasury, which used the CARES Act to provide $35 billion to cover whatsoever potential losses. (Come across hither for additional details.) The Municipal Liquidity Facility stopped purchases on Dec 31, 2020 when it lost Treasury support, per Secretary Mnuchin's decision. The New York MTA secured a 2nd loan from the facility on December 10, 2020, borrowing $2.nine billion before lending halted.
• Supporting municipal bond liquidity: The Fed also used ii of its credit facilities to backstop muni markets. Information technology expanded the eligible collateral for the MMLF to include municipal variable-rate demand notes and highly rated municipal debt with maturities of upwards to 12 months. The Fed also expanded the eligible collateral of the CPFF to include loftier-quality commercial paper backed by tax-exempt state and municipal securities. These steps allowed banks to funnel cash into the municipal debt market, where stress had been edifice due to a lack of liquidity.

WHY WERE THE FED'S ACTIONS IMPORTANT?

Steps taken past federal, land, and local officials to mitigate the spread of the virus limited economic action, leading to a sudden and deep recession with millions of jobs lost. The Fed'due south actions ensured that credit continued to flow to households and businesses, preventing financial marketplace disruptions from intensifying the economic damage.

In many other countries, nearly credit flows through the banking system. In the U.S., a substantial amount of credit flows through upper-case letter markets, so the Fed worked to keep them functioning as smoothly as possible. As one of our colleagues, Don Kohn, quondam Federal Reserve Vice Chair, said in March 2020:

"The Treasury marketplace in item is the foundation for trading in many other securities markets in the U.S. and around the globe; if it'due south disrupted, the operation of every market will be impaired. The Fed's purchase of securities is explicitly aimed at improving the performance of the Treasury and MBS markets, where market liquidity had been well below par in contempo days."

Just targeting the Treasury market proved insufficient, given the severity of the COVID recession and the disruption of flows of credit across other fiscal markets. And then the Fed intervened directly in the markets for corporate and municipal debt to ensure that key economic actors could heighten funds to pay workers and avoid bankruptcies. These measures aimed to help businesses survive the crisis and resume hiring and product when the pandemic ebbed.

Banks likewise needed support to go along credit flowing. When financial markets are clogged, firms tend to depict on bank lines of credit, which can lead banks to pull back on lending or selling Treasury and other securities. The Fed supplied unlimited liquidity to financial institutions and so they could see credit drawdowns and make new loans to businesses and households feeling financial strains.

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The authors did not receive fiscal support from whatsoever business firm or person for this commodity or from any firm or person with a fiscal or political interest in this article. They are not currently an officers, directors, or board members of whatsoever organization with a financial or political interest in this article. Prior to his consulting work for Brookings, Dave Skidmore was employed past the Board of Governors of the Federal Reserve System.

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Source: https://www.brookings.edu/research/fed-response-to-covid19/

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