Monetary Policy in the Pandemic Era: Comparison to 2008-2009 Financial Crisis and Implications

Monetary Policy in the Pandemic Era: Comparison to 2008-2009 Financial Crisis and Implications

The presentation, (located here: “Monetary Policy in the Pandemic Era: Comparison to 2008-2009 Financial Crisis and Implications”), was presented by Mickey D. Levy to the Global Interdependence Center’s 38th Annual Monetary and Trade Conference on November 19. Its key points are:

*The pandemic and government shutdowns differ fundamentally from the 2008-2009 Great Financial Crisis (GFC), involving a temporary downward shift in aggregate demand and supply. The Fed’s monetary policy responses have been far more expansive in magnitude and scope and more aggressive in timing. Income support through fiscal policies have also been sizable (the CARES Act has involved deficit spending of 13% of GDP).

*These government initiatives have supported a solid economic recovery. But, full recovery hinges on health matters and more excess liquidity or sustained low rates will not help. The Fed’s ability to stimulate further recovery is limited. While inflation is expected to remain low in 2021, inflation risks are decidedly to the upside beginning in 2022. U.S. bond yields will eventually rise from their current low levels. The U.S. dollar is expected to recede further.

*In addition to the Fed’s massive purchases of treasuries ($2.1 trillion) and mortgage-backed securities ($679 billion), the Fed’s lender of last resort facilities have included purchasing corporate and municipal bonds (small in magnitude but big in financial market impact) and direct lending to businesses. These extend the Fed into credit and fiscal policies normally conducted by Congress and the Treasury, and entangle the Fed directly in politics and thereby threaten its independence.

*The Fed’s asset purchases — its balance sheet has grown from $4.3 trillion to $7.2 trillion — combined with the impacts of the government’s income support that boosted disposable incomes and increased personal saving and bank deposits, has resulted in a dramatic spurt in both the monetary base (reserves plus currency) and M2. This contrasts sharply with the Fed’s QEs around the GFC. Those asset purchases generated a spurt in bank reserves, but did not generate a sustained pick up in M2 or an acceleration in economic activity. This current broad-based money growth and historically large household saving suggest significant consumer purchasing power when the pandemic ebbs.

*The Fed is expected to sustain its current ultra-easy policies. The Fed’s new strategic framework favors higher inflation and it fears prematurely unwinding its expansive policies in a way that would jar financial markets and the economic recovery.

*The Fed and other global central banks — including the BoE, ECB and BoJ — have extended their mandates well beyond the natural scopes of monetary policy. At the same time, mounting government debt, particularly in Japan and the U.S., pose the risks of fiscal dominance of monetary policy. The expanded scope of central banks, bloated balance sheets and sustained ultra-low interest rates distort finance and involve significant risks, including the risks of financial instability.

Mickey Levy, mickey.levy@berenberg-us.com

Member FINRA & SIPC
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