Yesterday I flagged a couple of interesting articles on the actions the Fed was taking to respond to the economic consequences of the pandemic. In that spirit, Cecchetti and Schoenholtz’s “Money and Banking” blog has a post that goes into some of the background issues including the ways in which the political consequences of these measures need to be dealt with.
Over the past two weeks, the Federal Reserve has resurrected many of the policy tools that took many months to develop during the Great Financial Crisis of 2007-09 and several years to refine during the post-crisis recovery. The Fed was then learning through trial and error how to serve as an effective lender of last resort (see Tucker) and how to deploy the “new monetary policy tools” that are now part of central banks’ standard weaponry.
The good news is that the Fed’s crisis management muscles remain strong. The bad news is that the challenges of the Corona War are unprecedented. Success will require extraordinary creativity and flexibility from every part of the government. As in any war, the central bank needs to find additional ways to support the government’s efforts to steady the economy. A key challenge is to do so in a manner that allows for a smooth return to “peacetime” policy practices when the war is past.
In this post, we review the rationale for reintroducing the resurrected policy tools, distinguishing between those intended to restore market function or substitute for private intermediation, and those meant to alter financial conditions to support aggregate demand.The Fed Goes to War; Money and Banking, 23 March 2020
The politics of this are covered by their post here
Our concern is with the legitimate and sustainable delegation of authority in a democracy. Given the distributional consequences associated with the purchase of private equity or debt, Congress and the President should explicitly authorize and allocate funds for any government acquisition. And, since this can be viewed as a form of partial nationalization, we doubt that the central bank—which needs to preserve its independence in peacetime—should be directly involved. Importantly, limiting the credit risk on the balance sheet of the central bank (even if there are fiscal guarantees) makes exit easier when the time comes. Even when credit risk is absent, think of how the distributional consequences of selling mortgage-backed securities (MBS) make it so much easier to shrink holding of Treasurys.Ibid