New claims for state unemployment insurance fell last week, but layoffs continue to come at an extraordinarily high level by historical standards.
Initial claims for state benefits totaled 790,000 before adjusting for seasonal factors, the Labor Department reported Thursday. The weekly tally, down from 866,000 the previous week, is roughly four times what it was before the coronavirus pandemic shut down many businesses in March.
On a seasonally adjusted basis, the total was 860,000, down from 893,000 the previous week.
“It’s not a pretty picture,” said Beth Ann Bovino, chief U.S. economist at S&P Global. “We’ve got a long way to go, and there’s still a risk of a double-dip recession.”
The situation has been compounded by the failure of Congress to agree on new federal aid to the jobless.
A $600 weekly supplement established in March that had kept many families afloat expired at the end of July. The makeshift replacement mandated by President Trump last month has encountered processing delays in some states and has funds for only a few weeks.
“The labor market continues to heal from the viral recession, but unemployment remains extremely elevated and will remain a problem for at least a couple of years,” said Gus Faucher, chief economist at PNC Financial Services. “Initial claims have been roughly flat since early August, suggesting that the pace of improvement in layoffs is slowing.”
New claims for Pandemic Unemployment Assistance, an emergency federal program for freelance workers, independent contractors and others not eligible for regular unemployment benefits, totaled 659,000, the Labor Department reported.
Federal data suggests that the program now has more beneficiaries than regular unemployment insurance. But there is evidence that both overcounting and fraud may have contributed to a jump in claims.
The lapse of enhanced jobless benefits amid a record-breaking crush of applications is exposing the flaws and shortcomings of how the U.S. provides unemployment insurance.
The economic toll of the coronavirus pandemic has torn holes in a federal safety net woven by individual systems for every state plus the District of Columbia, Puerto Rico and the Virgin Islands. More than 30.2 million Americans were on some form of unemployment insurance as of mid-July, with the Labor Department reporting a growing number of new applications in subsequent weeks.
Friday’s expiration of a $600 weekly add-on to state benefits plunged those vulnerable Americans into financial peril.
Congressional Democrats and Trump administration officials are now deadlocked over negotiations for a broader coronavirus relief package that’s expected to include some form of federal unemployment benefits.
But short-staffed unemployment offices across the U.S. grappling with outdated technology and unprecedented demand would face challenges from implementing a scaled-down or more complicated approach to the weekly payments.
Economists and labor market experts also warn that any solution that emerges from the negotiations would take weeks, if not months, to get up and running, risking a potentially catastrophic fiscal cliff for tens of millions of U.S. households.
“You ought to be able to deliver the program that’s on the books,” said Douglas Holtz-Eakin, former director of the Congressional Budget Office and a White House economist under former President George W. Bush.
“The states, collectively, seem to have not kept up the systems and we now have a big problem because of that,” he added.
The unprecedented size and speed of the pandemic-driven economic collapse has posed a brutal challenge for state unemployment agencies. After 10 years of steady economic expansion, the labor market quickly went from the lowest unemployment rate in 50 years to the highest level of joblessness since the Great Depression.
New claims for unemployment benefits were averaging roughly 200,000 nationwide a week before the pandemic — a manageable level for state agencies that had largely been neglected during the longest stretch of growth in modern U.S. history. But the coronavirus lockdowns spurred 3.3 million new claims between March 15 and March 22, a then-record that would be doubled the following week. Before the COVID-19 outbreak, the previous record was 695,000 from the first week of October 1982.
A little more than four months after the pandemic hit, state agencies are now processing roughly 2 million new claims a week for both unemployment insurance and Pandemic Unemployment Assistance (PUA), a program designed to cover those who don’t qualify for typical benefits.
“On some level, you can’t really blame states for not being prepared for that level of onslaught,” said Michele Evermore, senior policy analyst at the National Employment Law Project.
“Usually, you see the recession starting up and state agencies say ‘You know, this looks like a recession here, so let’s start to staff up.’ This came on all at once, so we’ve had these neglected, antiquated systems and then there’s all these other stressors.”
The U.S. economy has been in recession since February, according to the National Bureau of Economic Research.
Processing the massive surge of unemployment claims on shoddy technology would have been hard enough for states. Adding enhanced benefits and PUA claims to the mix strained state agencies even more.
“It took time to upgrade those systems. It took time to hire and train new staff who could deal with the volumes of the calls, and all in a pandemic, when face-to-face contact and training and being together in office were not possible,” said Julia Pollak, labor economist at job recruitment and posting company ZipRecuriter.
“So it’s easy to see in hindsight why it all fell apart.”
Enhanced unemployment benefits are among the biggest obstacles to reaching a deal on what’s likely to be the last coronavirus relief package before the election. While President Trump and Republicans are divided over how and whether to extend the federal boost, Democrats are largely united behind extending the benefits and reducing them gradually along a curve tied to the unemployment rate.
Speaker Nancy Pelosi (D-Calif.) has called for including such a mechanism, known as an automatic stabilizers, in the coronavirus package being negotiated.
Rep. Don Beyer (D-Va.), vice chair of the Joint Economic Committee, introduced a separate bill designed to tackle economic downturns beyond the coronavirus recession. His measure would establish a six-tier system for reducing the federal benefit in line with a state’s unemployment rate.
The approach was endorsed by former Federal Reserve Chairman Ben Bernanke, who oversaw the central bank’s response to the Great Recession, and his successor, Janet Yellen.
“Every time you get close to a cliff and there’s a political battle and political price to be paid, probably by both sides, rather than just saying ‘This is what’s needed,’ let’s kick it in,” Beyer said in an interview.
“We talked to economists all across the country and virtually everyone we talked to said this makes the most sense.”
But Republican lawmakers and right-leaning economists have pushed back on efforts to codify mandatory spending and make decisions now about what will be needed to mitigate future crises.
“It’s hard for me to understand why it’s appropriate now to anticipate the economic conditions in the future and tie the hands of future elected representatives of Congress,” Holtz-Eakin said.
“It forked out $2.3 trillion in [the CARES Act] across the board in ways that got to small businesses, to households, to the employed, the unemployed. If you’re going to have one in 100-year events, that’s how you deal with them,” he added.
Republicans have instead proposed replacing the flat $600 weekly boost with a percentage of the worker’s pre-pandemic earnings in addition to what is prescribed by each state. While the wage-replacement is more tailored, Evermore warned that making the necessary calculations for each claimant could overwhelm an already teetering system.
“If you told states that they had to do a percentage replacement — oh, my gosh, that’s a recipe for crashing everything,” she said.
“It’s just not how the system is set up to work.”
The Federal Reserve is keeping interest rates unchanged at close to zero, but the Fed is also extending programs to buy Treasuries and mortgage-backed securities.
Job gains from May and June came “sooner and stronger” than expected, Powell said. But those encouraging signs were closely followed by a surge in coronavirus cases nationwide. Powell said that at the same time people’s lives depend on containing the public health crisis, it is also important to “deal with the economic ramifications.”
Powell said some measures of consumer spending, based on debit card and credit card use, have moved down since late June. Powell also mentioned recent labor market indicators that are pointing to slower job growth, especially for smaller businesses. Hotel occupancy rates have flattened out, Powell said, while Americans are not going to restaurants, gas stations and beauty salons as much as they had been earlier in the summer.
Powell said the upcoming jobs reports and other surveys will help flesh out the Fed’s economic outlook, cautioning that he did not “want to get ahead of where the data are on this.” But as he has for months, Powell again emphasized that the economy’s recovery depends on the country’s ability to stop the virus from spreading.
“The path of the economy is going to depend, to a very high extent, on the course of the virus and on the measures we take to keep it in check,” Powell said. “The two things are not in conflict. Social distancing measures and a fast reopening of the economy actually go together. They’re not in competition with each other.”
As expected, the Fed’s policymaking board decided to keep interest rates, which are already near zero, unchanged as it concluded two days of policy meetings this week. Markets responded optimistically to the news, with the Dow Jones industrial average ending up 160 points at Wednesday’s close.
The Federal Reserve signaled in its statement on Wednesday that the Fed would continue to use “its full range of tools” to steer the economy out of recession, even as the virus significantly shapes the future of the economy.
“The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term,” the Fed’s top panel of policymakers said in a statement at the conclusion of two days of meetings.
After sharp declines, economic activity and employment “have picked up somewhat in recent months,” the Fed said. Economists have been closely watching July indicators, which could help explain whether the recovery from earlier this summer is beginning to fizzle as some states and cities reimpose restrictions on businesses to combat rising coronavirus cases.
“Overall financial conditions have improved in recent months, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses,” the Fed statement read.
To support the flow of credit to households and businesses, the Fed said it would increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace over the coming months. The Fed has said its support of the markets should remain in place to help safeguard the broader financial system during the pandemic.
At his news conference, Powell said the Fed was committed to keeping its lending facilities and other emergency measures in place not only during the shutdown and reopening, but also through the “long tail where a large number of people are struggling to get back to work.”
“We’re in this until we’re well through it,” Powell said.
Powell’s news conference comes as Congress clashes over another stimulus bill and an extension for enhanced unemployment benefits. On Tuesday, President Trump brushed off the new $1 trillion Senate GOP coronavirus legislation as “sort of semi-irrelevant.”
Powell has repeatedly said that the Fed cannot heal the economy alone and that more help will be needed from Congress to ease the pain for millions of Americans. On Wednesday, Powell said funding from the Cares Act has been key to keeping people in their homes and jobs. He praised the Paycheck Protection Program, for example, for getting money directly to businesses that couldn’t necessarily have been saved through a Fed lending program.
“Lending is a particular tool, and we’re using it very aggressively, but fiscal policy is essential here,” Powell said. “As I’ve said, more will be needed from all of us, and I see Congress is negotiating now over a new package, and I think that’s a good thing.”
Powell has stopped short of telling lawmakers exactly what they should do, or how urgently they should act, saying it isn’t his role to tell other parts of government how to do their jobs. But on Wednesday, Powell pushed the success of Congress’s earlier programs as reason for lawmakers to act again, said Skanda Amarnath, research director of Employ America, a policy group that advocates for full employment and higher wages.
Amarnath said Powell’s framing could give some cover to Republican lawmakers who are less convinced more help is needed, or who dispute the connection between the virus and the recovery.
“[Powell] is trying to reiterate that you can’t think of this as ‘either or,’ ” Amarnath said, adding that when it comes to tackling the pandemic and the economy, “you’re going to have to tackle one to tackle the other.”
For months, Powell has insisted that the virus will dictate an economic turnaround, which he says can’t happen until Americans feel safe going about their daily routines. Since the Fed’s last meeting in June, rising case counts have forced states to reimpose restrictions on business activity. Minutes from the Fed’s June meeting showed officials were worried the United States could enter a much worse recession later this year if the pandemic is not contained.
At this week’s Fed meeting, Fed leaders were expected to discuss other policy tools, such as forward guidance and asset purchases, without necessarily coming away with any firm conclusions. Economists are also awaiting the release of the Fed’s long-term monetary policy review, which could change the way the Fed approaches its inflation target.
The second quarter GDP report confused many, but any way you slice it, the economy saw its worst quarter in at least 145 years.
The Commerce Department opened today’s announcement of second-quarter economic growth with an eyeball-blistering observation: “Real gross domestic product (GDP) decreased at an annual rate of 32.9 percent in the second quarter of 2020.”
That 32.9 percent represents the loss of a third of the economy. Let that sink in. Now let it wriggle back out again — it is not exactly true. Why? The Commerce Department reports quarterly GDP at an annual rate to allow easy comparisons to other time periods. Remove the annualization, and we see the economy contracted a still-abysmal 9.5 percent.
In other words, 32.9 percent is how much the economy would shrink if the business closures and spending cuts of the second quarter increased at a compounding 9.5 percent for an entire year, after adjusting for seasonality.
Think of what an apocalypse that would be. Annualization assumes the businesses closed this quarter would remain closed and that just as many more would close in the third quarter. And we’d expand the closures again in the fourth quarter and again in the first quarter of next year.
In other words, take the devastation you saw in the past three months and multiply it by four. That is essentially what annualizing does, though compounding means the actual math is a bit more complicated.
The Commerce Department’s affection for annualization does not stop at percentage change. It also reports quarterly GDP totals at an annualized rate — when Commerce says GDP was at $17.2 trillion in the past quarter, it means GDP would be at $17.2 trillion if this quarter’s $4.3 trillion in output continued for a full year.
With that in mind, here is U.S. GDP, adjusted for inflation and reported as quarterly totals, as suggested by reader Nick Estes.
That chart does not crash by a third, obviously. A 32.9 percent drop would mean a loss of about $1.6 trillion from last quarter. In fact, the economy shrank $0.45 trillion in the second quarter, on the heels of a $0.06 trillion (1.3 percent) decrease in the first quarter of 2020.
To see a third of the economy truly vanish, look at the Great Depression. From 1929 to 1933, GDP contracted about 36 percent, according to data collected by economists Nathan Balke and Robert Gordon. That is the actual contraction — no annualization in sight.
Commerce Department data, which start in 1947, show the previous worst quarter on record was a 2.6 percent drop in 1958. That contraction just happened to coincide with the “Asian flu” pandemic, which claimed about a million lives worldwide.
With Balke and Gordon’s expanded data, we can also establish that a drop of 9.5 percent makes this quarter the worst since at least 1875. The next worst were in 1893, when a legendary panic and run on the banks resulted in a long, painful depression, and 1937, when the Great Depression took a turn for the worse. Then, we saw drops of 8.4 percent and 7.2 percent, respectively.
Economy Shrank At 32.9% Rate In 2nd Quarter
Percent change from the preceding period, seasonally adjusted annual rate
The coronavirus pandemic triggered the sharpest economic contraction in modern American history, the Commerce Department reported Thursday.
Gross domestic product — the broadest measure of economic activity — shrank at an annual rate of 32.9% in the second quarter as restaurants and retailers closed their doors in a desperate effort to slow the spread of the virus, which has killed more than 150,000 people in the U.S.
The economic shock in April, May and June was more than three times as sharp as the previous record — 10% in 1958 — and nearly four times the worst quarter during the Great Recession.
“Horrific,” said Nariman Behravesh, chief economist at IHS Markit. “We’ve never seen anything quite like it.”
Another 1.43 million people filed for state unemployment last week, an increase of 12,000, the Labor Department reported Thursday. It was the second week in a row of increased unemployment filings and shows that the economic picture continues to remain grim.
GDP swings are typically reported at an annual rate — as if they were to continue for a full year — which can be misleading in a volatile period like this. The overall economy in the second quarter was 9.5% smaller than during the same period a year ago.
After a sharp drop in March and April, economic activity began to rebound in May and June, although that recovery remains halting and could be jeopardized by a new surge of infections.
“As soon as the virus started to take off again in key states like Texas, California, Arizona, Florida, it’s fading very rapidly,” Behravesh said.
Restaurant owner Cameron Mitchell likens the pandemic to a hurricane. What appeared to be a business rebound in June turned out to be merely the eye of the storm, and he’s now being buffeted by gale-force winds again.
“Our associates are more scared to work today and guests are more afraid to go out, so sales have dropped,” Mitchell said.
Business at his restaurants in Florida had nearly recovered to pre-pandemic levels in June but has since fallen sharply.
Other industries have enjoyed a more durable recovery, though few are back to where they were in February.
Dentists’ offices are ordinarily one of the more stable parts of the economy, but they closed for all but emergency services during much of the spring. Dental hygienist Alexis Bailey was out of work for 10 weeks before her office in Lansing, Mich., reopened at the end of May.
At first, she was reluctant to go back to work while the virus was still circulating.
“I was terrified,” Bailey said. “I was not happy to be back. But I have a job to do and I like to do it and I want to help people. We talk about how essential we are, so that’s what we’ve had to do.”
Within an hour of returning to work, Bailey said, she began to feel comfortable, particularly with the additional protective gear and other safety precautions her office has adopted.
“I tell my patients all the time I wouldn’t be here if I didn’t feel safe,” she said.
Nationwide, dental offices added more than a quarter-million jobs in May and another 190,000 in June. And there has been no shortage of patients.
She thought no one would want to come. “But we’re booked,” Bailey said. “People miss getting their teeth cleaned. They want to catch up. Every time they come in, they say, ‘This has been nice to get out of the house and feel safe and talk to somebody.’ ”
Factory production has also begun to rebound, along with construction. But airlines and amusement parks are still struggling.
“It’s very much a sort of two-tiered economy right now,” Behravesh said.
The unemployment rate approached 15% in April, and in June it was still higher — at 11.1% — than during any previous postwar recession.
While the drop in GDP was largely driven by a decline in consumer spending, the economic fallout was cushioned somewhat by an unprecedented level of federal relief.
Wages and salaries fell sharply in April, but that was more than offset by the $1,200 relief payments that the government sent to most adults and by supplemental unemployment benefits of $600 per week.
Those government payments helped prevent an even steeper drop in consumer spending — the lifeblood of the U.S. economy — and allowed struggling families to buy groceries and pay rent.
Federal Reserve Chair Jerome Powell said Wednesday that the money “has been well spent. It has kept people in their homes. It has kept businesses in business. So that’s all a good thing.”
Those extra unemployment benefits are expiring this week, though. With coronavirus infections still threatening the recovery, additional federal support is likely to be necessary.
“Until we get the virus under control, we’re going to need more help,” Behravesh said. “Our view is that we’re not going to get to the pre-pandemic levels of economic activity until some time in 2022.”
Restaurant owner Mitchell says his business lost $700,000 in June alone. He predicts a wave of restaurant bankruptcies unless the federal government provides more relief.
“No one is looking for a handout here,” he said. “We’re looking to survive.”
He’s watching news of vaccine trials closely in hopes that eventually diners will feel comfortable eating out again in large numbers.
“I don’t think it’s the next couple of weeks,” he said. “But I tell our team, ‘Every day that goes by, it’s one day closer to the end of this thing.’ ”
Restaurant reservations are waning. The rebound in air travel is leveling off. And foot traffic at stores is dwindling once again. There is mounting evidence that America’s fragile economic recovery is already stalling as the number of coronavirus infections and deaths spike.
Recovery hopes overdone?
No vaccine, no recovery?
Nationwide, state and local government leaders are warning of major budget cuts as a result of the pandemic. One state – New York – even referred to the magnitude of its cuts as having “no precedent in modern times.”
Declining revenue combined with unexpected expenditures and requirements to balance budgets means state and local governments need to cut spending and possibly raise taxes or dip into reserve funds to cover the hundreds of billions of dollars lost by state and local government over the next two to three years because of the pandemic.
Without more federal aid or access to other sources of money (like reserve funds or borrowing), government officials have made it clear: Budget cuts will be happening in the coming years.
And while specifics are not yet available in all cases, those cuts have already included reducing the number of state and local jobs – from firefighters to garbage collectors to librarians – and slashing spending for education, social services and roads and bridges.
In some states, agencies have been directed to cut their budget as much as 15% or 20% – a tough challenge as most states prepared budgets for a new fiscal year that began July 1.
As a scholar of public administration who researches how governments spend money, here are the ways state and local governments have reduced spending to close the budget gap.
State and local governments laid off or furloughed 1.5 million workers in April and May.
They are also reducing spending on employees. According to surveys, government workers are feeling personal financial strain as many state and local governments have cut merit raises and regular salary increases, frozen hiring, reduced salaries and cut seasonal employees.
Washington state, for example, cut both merit raises and instituted furloughs.
A survey from the National League of Cities shows 32% of cities will have to furlough or lay off employees and 41% have hiring freezes in place or planned as a result of the pandemic.
Employment reductions have met some resistance. In Nevada, for example, a state worker union filed a complaint against the governor to the state’s labor relations board for violating a collective bargaining statute by not negotiating on furloughs and salary freezes.
Most of the employee cuts have been made in education. Teachers, classroom aids, administrators, staff, maintenance crews, bus drivers and other school employees have seen salary cuts and layoffs.
The job loss has hurt public employees beyond education, too: librarians, garbage collectors, counselors, social workers, police officers, firefighters, doctors, nurses, health aides, park rangers, maintenance crews, administrative assistants and others have been affected.
Residents also face the consequences of these cuts: They can’t get ahold of staff in the city’s water and sewer departments to talk about their bill; they can’t use the internet at the library to look for jobs; their children can’t get needed services in school.
Most of these cuts have been labeled temporary, but with the extensions to stay-at-home orders and a mostly closed economy, it will be some time before these employees are back to work.
Suspending road, bridges, building and water system projects
As another way to reduce costs quickly, a National League of Cities survey shows 65% of the municipalities surveyed are stopping temporarily, or completely, capital expenditure and infrastructure projects like roads, bridges, buildings, water systems or parking garages.
In New York City, there is a US$2.3 billion proposed cut to the capital budget, a fund that supports large, multiyear investments from sidewalk and road maintenance, school buildings, senior centers, fire trucks, sewers, playgrounds, to park upkeep. There are potentially serious consequences for residents. For example, New York housing advocates are concerned that these cuts will hurt plans for 21,000 affordable homes.
Suspending these big money projects will save the government money in the short term. But it will potentially harm the struggling economy, since both public and private sectors benefit from better roads, bridges, schools and water systems and the jobs these projects create.
Delaying maintenance also has consequences for the deteriorating infrastructure in the U.S. The costs of unaddressed repairs could increase future costs. It can cost more to replace a crumbling building than it does to fix one in better repair.
Cities and towns hit
In many states, the new budgets severely cut their aid to local governments, which will lead to large local cuts in education – both K-12 and higher education – as well as social programs, transportation, health care and other areas.
New York state’s budget proposes that part of its fiscal year 2021 budget shortfall will be balanced by $8.2 billion in reductions in aid to localities. This is the state where the cuts were referred to in the budget as “not seen in modern times.” This money is normally spent on many important services that residents need everyday –mass transit, adult and elderly care, mental health support, substance abuse programs, school programs like special education, children’s health insurance and more. Lacking any of these support services can be devastating to a person, especially in this difficult time.
Fewer workers, less money
As teachers and administrators figure out how to teach both online and in person, they and their schools will need more money – not less – to meet students’ needs.
Libraries, which provide services to many communities, from free computer use to after-school programs for children, will have to cut back. They may have fewer workers, be open for fewer hours and not offer as many programs to the public.
Parks may not be maintained, broken playground equipment may stay that way, and workers may not repave paths and mow lawns. Completely separate from activists’ calls to shift police funding to other priorities, police departments’ budgets may be slashed just for lack of cash to pay the officers. Similar cuts to firefighters and ambulance workers may mean poorly equipped responders take longer to arrive on a scene and have less training to deal with the emergency.
To keep with developing public safety standards, more maintenance staff and materials will be needed to clean and sanitize schools, courtrooms, auditoriums, correctional facilities, metro stations, buses and other public spaces. Strained budgets and employees will make it harder to complete these new essential tasks throughout the day.
To avoid deeper cuts, state and local government officials are trying a host of strategies including borrowing money, using rainy day funds, increasing revenue by raising tax rates or creating new taxes or fees, ending tax exemptions and using federal aid as legally allowed.
Colorado was able to hold its budget to only a 3% reduction, relying largely on one-time emergency reserve funds. Delaware managed to maintain its budget and avoided layoffs largely through using money set aside in a reserve account.
Nobody knows how long the pandemic, or its economic effects, will last.
In the worst-case scenario, budget officials are prepared to make steeper cuts in the coming months if more assistance does not come from the federal government or the economy does not recover quickly enough to restore the flow of money that governments need to operate.
In many respects this recession is unique. Most recessions result from developments inside the economy, but an external shock—the public health crisis—caused this one. To avoid getting sick, people have curtailed working, shopping, and attending school. Whatever the cause, the coronavirus recession, like all recessions, is imposing heavy costs. Many workers have lost jobs and income, and many business owners’ financial survival is at risk. The economy’s extraordinarily rapid decline earlier this year—as well as the sharp but incomplete rebound following the first steps toward reopening—reflect this recession’s unusual source. In addition, the sectors suffering most differ from past recessions. The heaviest blows have fallen on service industries that involve close personal contact (including retail trade, leisure and hospitality, and transportation) rather than, as is more typical, on the housing, capital investment, and durable goods sectors. Lower-paid workers, as well as women and minorities, are over-represented in the most-affected sectors, and thus have borne a disproportionate share of the job and income losses. And, the virus has affected almost every country, with potentially devastating consequences for trade and international investment.
Because this recession is unprecedented in so many ways, forecasting the recovery is difficult. The course of the pandemic itself is by far the most important factor. As long as people fear catching a potentially deadly illness from other people, they will be cautious about resuming normal activities, even after state and local governments lift lockdowns. Thus, controlling the spread of the virus must be the first priority for restoring more-normal levels of economic activity—but, more importantly, for saving possibly tens of thousands of lives. Members of Congress, local leaders, and other policymakers need to do all they can to support testing and contact tracing, medical research, and sufficient hospital capacity, and they must work to ensure that businesses, schools, and public transportation have what they need to operate safely. Both authors of this testimony are serving on state re-opening commissions, which has provided us insight into the substantial challenges to safe re-opening.
If the pandemic comes under better control, economic recovery should follow. However, the pace of the recovery could be slow and uneven, for several reasons. First, in the face of ongoing uncertainty, households and businesses may remain cautious for a time. They may increase saving and reduce spending, hiring, and capital investment. The longer the recession lasts, the greater the damage it will inflict on household and business balance sheets and the longer it will take to repair the damage. Second, the depth of the recession may leave scars—business closures and the deterioration of unemployed workers’ skills—that will affect growth for several years. Third, depending on the course of the virus, some restructuring of the economy may be needed. For example, people and resources will need to be redeployed out of the sectors most damaged by the pandemic, and business operations will need to be reorganized to protect workers and customers. All of that will take time and money. Fiscal and monetary policies must aim to speed the recovery and minimize the recession’s lasting effects.
ACTIONS BY THE FEDERAL RESERVE
The Federal Reserve has moved swiftly and forcefully in this crisis. It eased monetary policy in March by lowering the federal funds rate, the overnight interest rate on loans between banks, nearly to zero and indicating that it plans to keep rates low for several years. Low interest rates probably had limited economic benefits in the spring. Lockdowns prevented people from spending or working more. However, we expect low rates will spur spending in sectors like housing as the economy reopens. And the Fed may well do more in coming months as re-opening proceeds and as the outlook for inflation, jobs, and growth becomes somewhat clearer. In particular, to maintain downward pressure on longer-term interest rates, the Federal Open Market Committee (FOMC) likely will provide forward guidance about the economic conditions it would need to see before it considers raising its overnight target rate. And it likely will clarify its plans for further securities purchases (quantitative easing). It is possible, though not certain, that the FOMC will also implement yield-curve control by targeting medium-term interest rates. It could, for example, target two-year rates by announcing its willingness to buy two-year Treasury notes at a fixed yield. The completion of the Fed’s internal review of its tools and framework in coming months will help guide these decisions.
The Fed also has been active beyond monetary policy.
First, the Fed has served as market maker of last resort by acting to stabilize critical financial markets when capital or other regulatory constraints have interfered with normal market-making or arbitrage. The Fed has served this role for repurchase agreements (repos) since September, when intermittent liquidity shortages led to spikes in repo rates. Banks did not provide liquidity to offset these spikes, as they normally would, citing balance sheet limits and other constraints. Because repo markets are critical to the functioning of broader financial and credit markets, as well as for the transmission of monetary policy, the Fed has restored more-normal function in repo markets by conducting large-scale repo operations and by steadily increasing the quantity of reserves in the banking system.
An even larger shock occurred in March, when uncertainty about the pandemic led hedge funds and others to scramble to raise cash by selling longer-term securities. The upsurge in the supply of longer-term securities, including Treasuries, was more than dealers and other market-makers could handle. Key financial markets, including for Treasury securities, experienced substantial volatility. To stabilize these markets, which like the repo market play a critical role in our financial system, the Fed purchased large quantities of Treasuries and mortgage-backed securities, again serving as market maker of last resort. It also set up a new repo facility to allow foreign official institutions to borrow dollars, using their Treasury reserves as collateral, thus avoiding the need to sell those Treasuries. Although risk and liquidity premiums in these key markets have returned closer to normal, at some point the Fed and the Treasury will need to review why the market-making facilities in place before the pandemic hit did not work more efficiently.
Second, the Fed has served as lender of last resort to the financial system, a classic function of central banks. Banks and other financial intermediaries typically borrow short and lend long—that is, they rely heavily on short-term funding to finance long-term loans and investments. If they lose their short-term funding—because their funders lose confidence or for other reasons—they can be forced to sell their assets in fire sales, restrict credit to customers, and, in extreme cases, become insolvent. Central banks can short-circuit that dangerous dynamic by lending to financial institutions against good collateral, replacing the lost liquidity. In the 2007-2009 crisis, which centered on the financial system and included a global financial panic, the Fed as lender of last resort took many actions to provide liquidity to financial institutions, with the goal of stabilizing the system and preserving the flow of credit to the economy.
Fortunately, the financial system is in much better shape today than in was during the financial crisis. Banks in particular are strong, with much higher levels of capital and liquidity. The Fed nevertheless has once again taken steps to ensure that the financial system has sufficient liquidity. Largely replicating our playbook from the crisis era, the Fed has eased terms on the discount window (which provides short-term loans to banks); re-established the Primary Dealer Credit Facility (which lends to broker-dealers); and established a facility that lends indirectly to money market mutual funds, ensuring that the funds can meet depositor withdrawals. In a novel step, the Fed also created a facility that lends to banks, without recourse, against Payroll Protection Program loans, ensuring that banks have sufficient funds to make those loans.
Under the heading of lender of last resort to the financial system, establishing currency swap lines with fourteen foreign central banks was one of the most important actions the Fed took in the 2007-2009 crisis. The Fed has revived this program. Currency swap lines allow foreign central banks (who assume all the credit risk) to lend dollars to banks in their jurisdictions. The broad availability of dollar liquidity is essential because most global banks do substantial borrowing and lending in dollars, including lending within the United States. The swap lines sustain the flow of dollar credit and reduce volatility in dollar-based markets, to the benefit of the U.S. economy.
Third, the Federal Reserve, with the support of the Congress and the Treasury, has also served during the current crisis as a lender of last resort to the non-financial sector, backstopping key credit markets facing the prospect of severe disruption from the pandemic. To take on this role, the Fed invoked its emergency lending powers under Section 13(3) of the Federal Reserve Act. Since those powers require that the Fed’s lending be well secured, it has had to rely on funds appropriated by the Congress and allocated by the Treasury to cover possible losses. Using these authorities, the Fed revived financial crisis-era facilities to stabilize commercial paper and asset-backed securities markets. Going beyond the financial crisis playbook, the Fed has also added new facilities to lend to corporations and state and local governments and to buy outstanding corporate bonds.
These programs have not extended much credit, so far, but that does not mean they have not succeeded. By establishing the programs, the Fed gave private investors the confidence to re-engage by reassuring them that the government would not allow these critical markets to become dysfunctional. Indeed, the corporate and municipal bond markets largely stabilized after the announcements, before any loans were made. Of course, if these markets seize up again, the Fed’s programs can extend credit.
The Fed also established the Main Street Lending Program to lend (through banks) to medium-sized companies. It is too soon, however, to judge its performance. This program is very different from anything the Fed has attempted before and poses difficult technical challenges. Although the Fed took many public comments while setting up the program, and made substantial changes, questions remain about how many banks and borrowers will participate. The Fed and Treasury may have to further ease terms for borrowers and increase incentives for banks for this program to have the desired effect. Or, the Fed and Treasury could add a new facility, along the lines of funding-for-lending programs run by the Bank of England and the European Central Bank, that simply subsidize banks for making additional loans to qualifying borrowers (for example, businesses below a certain size). That approach leaves the underwriting decision completely with the banks, while the size of the subsidy can be adjusted as needed to achieve the desired level of lending.
Finally, the Fed has also taken actions as a bank regulator—for example, encouraging banks to work with borrowers hobbled by the pandemic. It decided recently, based on stress test results, to bar stock buybacks by banks and to limit—but not eliminate—their dividends. Based on our experience in the global financial crisis, we think the Fed may find it needs to go further. Although banks are currently strong, it is possible the pandemic will so damage the economy that credit losses mount rapidly. For a successful recovery, the banking system must remain strong and able to lend.
Is there more the Fed could do? As we noted, the Fed likely will provide more clarity about its monetary policy plans, and it may need to adjust the terms or borrower eligibility requirements of its various lending facilities. Broadly speaking, though, the Fed’s response has been forceful, forward-looking, and comprehensive. But, as Chair Powell often notes, the Fed’s authorities allow it to lend, not spend. Some households and firms will need subsidies or grants, rather than loans, and spending is, of course, the province of the Congress.
WHAT FISCAL POLICY MIGHT DO
The fiscal response to the pandemic has thus far been quite effective. Enhanced unemployment insurance and the Paycheck Protection Program have helped unemployed workers and their families, together with many businesses, survive the spring shutdowns. The fiscal support for the Fed’s lending programs likely will help preserve credit availability, possibly with only a portion of the allocated funds being spent.
However, some programs authorized by the Congress are ending, and new actions are necessary. Our recommendations for further fiscal action are:
First, Congress should develop a comprehensive plan to support medical research; increase testing, contact tracing and hospital capacity; make available critical supplies; and support state and local efforts to safely open businesses, schools, and public transportation.
Nothing is more important for restoring economic growth than improving public health. Investments in this area are likely to pay off many times over.