The economic shock of the coronavirus is very different from the housing bubble shock that caused the Great Recession of 2008-2009. Yet six months into the current crisis, we are in danger of repeating a same key mistake: leaning too hard on the Federal Reserve to navigate the crisis while ignoring the much more important role of a bloc in Congress that is blocking needed aid. While it is true that the Fed has shown better judgement over the course of this crisis, the tools it currently has available to address it are weak. The tools Congress has are strong, but their actions have been stymied by the mystifyingly bad judgement of Senate Republicans.
The Fed is an enormously powerful institution in many ways, but their policy tools are actually quite limited for boosting the economy out of a recession or even increasing the rate of growth during recoveries. The Fed can decisively slow economic expansions, and too often in the past they have done this explicitly to weaken workers’ bargaining position and keep wage-driven pressure on prices from forming. In short, the Fed has a powerful brake but a very weak accelerator, and their use of this brake has merited much criticism in the past.
"If the Fed is relatively weak in its ability to end recessions, why do its actions get so much attention during times of economic crisis?"
If the Fed is relatively weak in its ability to end recessions, why do its actions get so much attention during times of economic crisis? Mostly because the actions of Congress (dominated for the past decade by the Republican caucus in the Senate) have been either too weak or outright damaging during these crises. For example, in the weak recovery from the Great Recession of 2008-2009, austerity imposed by a Republican-led Congress throttled growth, even as historically aggressive actions by the Fed tried (only partly successful) to counter this fiscal drag. During this period, every new Fed decision about interest rate changes or quantitative easing (QE) sparked long and loud controversy, even while having a minimal economic effect. Yet the enormous cumulative damage of fiscal austerity stemming from Congressional actions like the Budget Control Act (BCA) of 2011 merited just a tiny fraction of this debate. Yet the damage done by the BCA utterly dwarfed the small (if admirable) attempts by the Fed to push the economy back to recovery.
In the current moment, there has been plenty of debate about what the Fed should do differently to ease the economic crisis. But again, it is Congress—hamstrung by Senate Republicans’ refusal to act—which has all the power to end this crisis. And “end this crisis” is not an overstatement. The playbook for dealing with the current economic crisis is pretty obvious: provide relief for families with workers put out of work by the shock for as long as labor markets remain damaged, direct resources to state and local governments whose revenues have been savaged by the shock just as spending demands have risen, and spend every last dollar that would be useful for getting the virus under control. If the federal government is currently too dysfunctional to figure out how to spend these dollars to control the virus, then this means the aid to state and local governments should be that much greater.
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Congress provided genuinely transformative relief to families in the CARES Act passed in March, but they cut off the aid far too early, assuming unrealistically that the virus would be under control in a matter of weeks. But for three months, the United States had a relatively generous and protective welfare state. There is no reason why Congress should not have continued this aid to families and provided generous and open-ended aid to state and local governments as well.
Some have argued that transferring resources to state and local governments is a power the Fed actually does have today, and that the Fed should take the lead on this. Some of these arguments are transparently cynical and meant only to justify congressional inaction. Others are more serious, and the Fed does have some scope here, but, again, the weaknesses of the Fed’s tools are too often underappreciated. Essentially, the Fed has the power to make loans, not grants. Their current program that makes loans to state and local governments—the municipal liquidity facility (MLF)—charges these governments more than market interest rates for debt. From an economic point of view, this is clearly dumb—the Fed should try to make these loan terms as generous as possible.
But, it is telling that state and local government debt even outside the MLF does not seem to be growing very fast even with interest rates in these markets very low (after some hiccups in those markets in March and April, which were largely tamped down by the Fed’s promised interventions). This was also true during the recovery from the Great Recession—very low municipal bond interest rates did not lead to a burst of state and local borrowing to support spending. What this should tell us is that the level of interest rates is not the real constraint here. Instead, it is state accounting and budget rules (set by law or in state constitutions) that provide a large hurdle for states thinking of taking on debt, whether market-based debt or debt through loans provided by the MLF. There is also ideology: The Republican electoral wave in 2010 led to governors and legislatures that were not going to spend more money regardless of how low interest rates on municipal bonds were.
If the Fed made radically large changes in how generous the terms of the MLF were (way beyond tweaking interest rates), would policymakers start quickly rewriting these state and local budgeting rules and begin piling on debt? For example, if the Fed charged negative interest rates on the loans and said that governments had 100 years to pay them back? From an economic viewpoint, this would indeed provide substantial relief to state and local governments. But, there are federal laws governing the loans the Fed can make, and it is far from clear that this would pass legal muster. While I wish it would pass muster—and I’m not that worried about the legality of this from a moral perspective—I worry that the Fed effectively usurping authority from Congress could spur Congress to respond with legislation that affirmatively reduced the future scope for the Fed to intervene during crises. Senate Republicans have made it very clear in the current moment that they do not want aid transferred to state and local governments. If the Fed declared it had the power to effectively transfer this aid and bypass Congress, would these Senators really sit idly by? This is a real potential cost to be reckoned with by those arguing for the Fed to test their legal limits super aggressively.
It’s obvious why many focus on the Fed and wish it would be more transformative in helping the economy out of crises—the Fed has cleared the very low bar of showing some level of competence and judgement in recent crises, while Congress has completely stumbled. But it’s Congress that has the tools needed to end the crisis, and it can use them anytime it wants. They—and the Senate Republican caucus that is the roadblock to using these tools—should be the focus of policy attention today. They shouldn’t be let off the hook simply because we presume they’re too incompetent (or malevolent) to be expected to act responsibly.
If a better Congress doesn’t appear, it may well be the case that we need to think hard about giving the Fed more effective tools to fight recessions in the future. It’s not impossible economically—we could give the Fed the legal right and administrative tools to transfer resources directly to people. But giving the Fed these expanded tools would require Congress to affirmatively grant them. In the end, there is no end-around a Congress that refuses to do what’s right for U.S. families.