• Second, they established or re-opened multiple credit facilities to supply liquidity to markets for short-term credit instruments, corporate bonds, municipal bonds as well as to backstop loans to small and medium-sized businesses.
• Third, they ramped up and expanded dollar swap arrangements with other central banks with the twin goals of ensuring the availability of dollar funding overseas and alleviating upward pressure on the exchange rate.
• Finally, after proposing to boost its holdings of Treasuries by $500 billion and mortgage securities by $200 billion on March 15th, the Fed then abandoned all limits on Quantitative Easing (QE) on March 23rd. As a result, since the end of February, the Fed’s holdings of U.S. Treasuries have increased by $1.4 trillion and the overall assets of the Fed, which also include additional mortgage securities, foreign central bank liquidity swaps and holdings in new and expanded credit facilities, have risen by $2.4 trillion.
On Wednesday of this week, at his post-FOMC press conference, Jay Powell will, no doubt, express the Fed’s determination to continue to support the economy at this uniquely stressful time. The principal avenue of that support will likely be further Treasury purchases, even as the economy begins to revive from this deep recession in 2021. However, it does beg the question of how far Washington can go in issuing and monetizing debt before everyone pays a price in terms of higher interest rates, higher taxes and higher inflation.
This is no easy question to answer. However, logically it should depend on the forces that suppressed inflation and interest rates in the last long economic expansion, the position of monetary and fiscal policy when the economy reaccelerates and the pace at which it reaccelerates.
On the first issue, it is worth noting that many worried about higher interest rates and inflation in the last expansion. These concerns were based on the simple monetarist argument that a big increase in bank reserves should lead to a big increase in the money supply and thereafter, a big increase in inflation.
In retrospect, this turned out to be wrong partly because, for regulatory and other reasons, bank lending and the money supply never increased nearly at the pace of bank reserves. In addition, caution among lenders to extend credit to riskier borrowers and steadily rising income inequality acted as a brake on the demand for goods and services and diverted income towards the purchase of financial assets. This lack of demand was amplified by fiscal austerity as the budget deficit, as a share of GDP, fell every year from 2010 to 2015.
In addition, on the supply side, globalization, in an environment of weaker overseas demand and rising U.S. dollar, helped hold down import prices, information technology made the markets for more goods and services more competitive and a fragmented and de-unionized labor force held wages in check.
Based on this experience, there is some risk of higher inflation and interest rates in the aftermath of this recession.
First, both the Federal Reserve and the Federal Government will likely be in a more expansionary mode. On the Fed side, the fact that this recession wasn’t preceded by a financial bubble will probably result in a more indulgent regulatory stance, encouraging more bank lending. In addition, the fiscal restraint during much of the Obama administration was due, in large part, to constraints placed on the administration by fiscally conservative congressional Republicans. However, the record of the last three years suggests that there are no fiscal conservatives left on either side of the aisle.