Fed warns of lasting economic damage

A protracted crisis due to the coronavirus can cause permanent damage to the economy. That's what Jerome Powell of the US central bank said in a speech this week. He fears that the disappearance of small and medium-sized businesses in particular will affect the economy's ability to recover. These companies create a lot of jobs and are therefore crucial for the recovery.

Furthermore, Powell warned of a long period of stagnation, because companies will invest less in the event of a poor economic outlook. Companies will then hire fewer staff, which means that the economy will need more time to recover. To date, low-income households have been particularly affected by the coronavirus crisis, as they work in sectors that have been hit hardest.

According to the chairman of the central bank, this crisis was different from others. Whereas previous crises were the result of structural imbalances or bubbles in the economy, he attributes this crisis entirely to the coronavirus.

"The current crisis is unique in that it is attributable to the virus and the steps taken to mitigate its impact. This time, high inflation wasn't a problem. There was no economically threatening bubble to burst and no unsustainable boom to crack. The virus is the cause, not the usual suspects – something worth bearing in mind as we respond."

'More stimulation may be needed'

The Federal Reserve has taken several measures to stabilize financial markets since the beginning of the crisis. The first step was to buy government bonds and mortgage loans, debt securities that are used as collateral within the financial system. She also injected billions into the repo market. Finally, the Fed came up with dollar swaps and an international repo facility to provide other central banks with dollar liquidity.

With this package of measures, the central bank tried to stabilize the international monetary and financial system. To prevent businesses and households from getting into trouble, the central bank came up with even more measures. Backed by a government guarantee, the Fed started buying corporate bonds this week. This will initially be done through the secondary market, but the central bank also plans to lend money directly to businesses and to US states.

Monetary financing

With the latter, the central bank is in fact doing monetary financing. It skips the market in order to be able to quickly provide money to companies in need. According to Powell, the central bank only takes these measures in extreme circumstances such as the one we are currently experiencing. He promised to put these monetary instruments back on the table as soon as this crisis is over.

After all, Powell emphasized in his speech that the U.S. central bank should only lend money and not spend it. The money that the Fed is now making available to the market should therefore be seen as an instrument to solve liquidity problems. The danger is that this crisis will last longer and that liquidity problems will turn into solvency problems. That is why the central banker is calling on the government to consider additional fiscal stimulus.

This contribution comes from Geotrendlines