Fed Cuts Rates, Restarts QE as Economic Outlook Deteriorates

Chief Economist Scott Brown discusses the Federal Reserve’s decision to cut interest rates to 0% and restart quantitative easing (QE).

In recent weeks, COVID-19 has led to escalating economic concerns. What started as a seemingly sharp, but likely temporary, reduction in Chinese activity, including disruptions to global supply chains, became more worrisome as the coronavirus moved to the rest of the world. Now spreading widely in the U.S., efforts to contain the virus have had a very sharp impact on travel, tourism, restaurants, sports and entertainment, almost certainly putting the U.S. economy into a recession. More troublesome still, credit market strains became apparent last week, threatening to further broaden the economic downturn.

To counter the downside economic risks of the virus, the Federal Reserve lowered short-term interest rates by 50 basis points between policy meetings on March 3. Last week, amid signs of credit market strain, the Fed provided $1.5 trillion in liquidity to the repo market. On Sunday, March 15, just two days ahead of the regularly scheduled policy meeting, the Fed lowered short-term interest rates further, bringing the target range for the federal funds rate to 0-0.25% (the lower limit reached during the financial crisis) and indicated that it would maintain this target range “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals” (in other words, for a long time). The Fed also announced further asset purchases (at least $500 billion of Treasuries and $200 billion of agency mortgage-backed securities).

In addition, the Fed has undertaken other actions to support the flow of credit to households and businesses. It lowered the discount rate (the rate the Fed charges banks for short-term borrowing) by 150 basis points, to 0.25%, and extended the period of loans offered to 90 days. The Fed eliminated reserve requirement ratios and encouraged banks to make use of intraday credit with the Fed and use their capital and liquidity buffers to support lending.

The U.S. dollar is important to the global economy. Strains in dollar borrowing abroad can disrupt financial conditions here. To address potential pressures in global markets, the Fed made a coordinated announcement with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank to reduce the pricing of dollar swap lines. These long-standing arrangements “carry no risk to the Federal Reserve or to the American taxpayer.”