ECONOMICS......

PAGE ONE Economics COVID-19's Effects on the Economy and the Fed's Response Jane Ihrig, Ph.D., Economist and Senior Adviser, Board of Governors of the Federal Reserve System Gretchen Weinbach, Ph.D., Economist and Senior Associate Director, Board of GLOSSARY Governors of the Federal Reserve System Scott Wolla, Ph.D., Economic Education Coordinator Discount window: Federal Reserve lending to depository institutions to support the liquidity and stability of the banking system and the effective implementation of monetary policy. The Federal Reserve's response to this extraordinary period has been Economic expansion: A period when real GDP guided by our mandate to promote maximum employment and stable increases; a period of economic growth. prices for the American people, along with our responsibilities to promote stability of the financial system."1 Federal funds rate: The interest rate depository institutions charge each other -Jerome H. Powell, Chair of the Board of Governors of the Federal Reserve System to borrow or lend reserves in the federal funds market; these funds are immediately available. What Does the Fed Do? Facility: A formal financial assistance program offered by a lending institution to help a As the central bank of the United States, the Federal Reserve's (Fed's) targeted set of counterparties (those eligi- mission is to promote the effective operation of the U.S. economy. It uses ble to borrow) with funding needs. The monetary policy-actions to achieve maximum employment and stable Federal Reserve has permanent facilities (like discount window credit) and tempo- prices (also known as its "dual mandate")-to support economic growth. rary facilities (like those implemented during Effective monetary policy complements fiscal policy-the use of govern- the Global Financial Crisis of 2007-09 and ment spending and tax policies to affect economic conditions. The Fed the COVID-19 pandemic). also promotes the stability of the financial system; stable financial markets Liquid asset: An asset that is easily convertible are necessary for a well-functioning economy. to cash with a consistently low cost of conversion. The Fed plays a particularly important role in quelling financial and eco- Policy rate: The interest rate that is used by a nomic crises. In fact, it was created in part to do just that: After decades of central bank to set and communicate its destabilizing banking panics and other crises, the Fed was founded in 1913 monetary policy stance (or position). In the United States, the Federal Reserve's Federal to provide the nation with a safe, flexible, and stable monetary and finan- Open Market Committee (FOMC) uses the cial system. When crises arise, the Fed is authorized to act as the "lender federal funds rate as the policy rate. of last resort." That is, in certain circumstances the Fed may provide funds Real gross domestic product (GDP): The to the financial system when they are urgently needed and market sources total market value of all final goods and have been exhausted. Doing so keeps the financial system functioning services produced in an economy in a given year calculated by using a base year's and prevents economic downturns from deepening. This authority came price for goods and services; nominal gross into play with the onset of the COVID-19 pandemic. Here we look at the domestic product (GDP) adjusted for substantial economic shock brought on by the pandemic and the steps inflation. the Fed took in the initial weeks to aid the economy. U.S. Treasury securities: Bonds, notes, and other debt instruments sold by the U.S. Treasury to finance U.S. government What Shape Was the U.S. Economy in Prior to the Pandemic? operations. In early 2020, before the pandemic took hold, the U.S. economy was in very good shape. February marked the 128th month (and the ultimateTable 1 COVID-19 Timeline in the United States, January to March 2020 January 21 First reported U.S. case January 30 First reported case of person-to-person transmission in the U.S. February 11 WHO (World Health Organization) announces a formal name for the coronavirus-COVID-19 FOMC holds unscheduled meeting: says coronavirus poses evolving risks to economic activity; lowers policy rate range 1/2 March 3 percentage point to 1 to 11/4 percent; says it's closely monitoring developments and their implications for the economic out- look and will use its tools and act as appropriate to support the economy March 6 President signs first emergency coronavirus aid package March 11 Confirmed U.S. cases reach 1,215 March 11 WHO declares COVID-19 outbreak a pandemic March 11 NBA suspends all basketball games March 12 MLB suspends spring training and delays start of regular baseball season March 12 NHL suspends hockey season March 12 NCAA cancels men's and women's college basketball tournaments March 13 States across the U.S. announce plans to close schools March 13 President declares national emergency FOMC holds another unscheduled meeting: says coronavirus has harmed communities, disrupted economic activity, and March 15 significantly affected global financial conditions; lowers policy rate range 1 percentage point to near zero (a 0 to 14 percent range); says will use its tools to support the economy, including flow of credit to businesses and households March 15 Fed announces series of actions to support flow of credit to households and businesses; first of many announcements made over coming weeks* March 15 CDC (Centers for Disease Control and Prevention) recommends cancelling or postponing in-person events of 50 people or more March 15 President issues guidelines to avoid gatherings of more than 10 people for next 15 days and limit discretionary travel March 15 Confirmed cases rise to 3,487 March 16 NASCAR postpones all races until at least May March 17 Kentucky Derby postponed until September March 17 Confirmed U.S. cases reach 7,038 March 18 Trading on Wall Street halted for fourth time in two weeks; S&P 500 Index falls 5 percent March 18 Confirmed U.S. cases top 10,440 March 18 President signs second emergency coronavirus aid package March 27 President signs the Coronavirus, Aid, Relief, and Economic Security (CARES) Act, the largest single spending bill in U.S. history NOTE: *All of the Fed's COVID-19-related announcements, which began February 28, can be found at https://www.federalreserve.gov/covid-19.htm. SOURCE: CDC (2020); Hauck et al. (2020); Muccari, Chow, and Murphy (2020); and Board of Governors of Federal Reserve System (various dates).peak) of the longest economic expansion in US. history. Employment was growing solidly, with February's unem- ployment rate of 3.5 percent the lowest in 50 years. Employees' wages were rising on the whole, although gradually. Lower-income workers were also benefitting from employment gains. Moreover, while ination was a bit low from the Fed's perspective, it was stable. Taken together, these indicators painted a rosy picture of a strong and stable economy. When the Pandemic Set In, What Happened to the US. Economy? The COVID-I 9 pandemic and the steps taken to protect public health hit the US. economy in early 2020 with con- siderable speed and scope. The United States announced its rst reported case of the virus on January 21 and the first death from it on February 29. To limit the spread of the virus, health experts recommended widespread social distancing (keeping a distance of at least six feet between people}. This policy resulted in the closing of all "no n- essential\" businesses and activities and the use of shelter- athome strategies for all non-essential employees, steps that many businesses and households implemented swiftly {Table 1). As a result, by mid-March, entire parts of the economy had been shut down, which had two major effects. First, economic activity was substantially disrupted, end- ing the US. economic expansion. Spending on goods and services plunged (Figure 1). With many businesses closed, millions of workers were laid off. The unemploy- ment rate surged to an 80-year hig hto 14.7 percent in April and 133 percent in May (Figure 2). More jobs were lost in the two months ending in April 2020 than had been created over the preceding expansion, which had lasted nine years {Figure 3). And the rise in joblessness was especially severe for lower-wage workers, women, African Americans, and Hispanics. Real gross domestic product (GDP), which measures the value of the nation's total economic output, fell at a 5 percent annual rate in the rst quarter of 2020 followed by an eye-popping 33 percent fall in the second quarter. Although these data provide a sense of the overall effects of the pandemic on the economy, they do not capture the severe hard- ships that set in for many, including the nancial stresses that can accompany sudden job loss. Second, and even more immediately, the economic shutdown severely affected US. nancial markets. Well before the data discussed above became available, it was increasingly clear that the pandemic would have serious adverse effects on the economy. And any disrup- tions to economic activity would also interrupt incoming earnings and other cash ows for many households, businesses, and state and local governments. In response to this growing realization, many businesses and investors sought to increase their holdings of cash and other very \"liquid\" assets, and some did so by selling their holdings of other assets. By early March, this rush to raise cash caused severe strains across many nancial markets. In US. Treasury securities markets, for example, the differ- ence between the prices offered to sell and buy some securities widened considerably, making it difficult for trades to occur (Figure 4]. Stress in the Treasury market, normally among the most liquid markets in the world, signaled nancial stresses more broadly.3 Indeed, many businesses and state and local govern ments that regu- larly cover their near-term expenses by selling short-term securities to raise cash started to have difculty raising enough money to operate, including for expenses such as payroll, leases, and payments to suppliers. The resul- tant \"liquidity squeeze\"where access to cash dries up even for those that had been operating smoothlyjust days beforewas particularly severe in mid-March and threatened to greatly amplify the pandemic's negative effects on the economy. How Did the Fed Respond? In keeping with its mission, the Fed acted swiftly to address the economic and financial effects of the pan- demic. It rapidly lowered the target range for its policy rate, the federal funds rate, to near zero to bolster the economy; took steps to stabilize the nancial system; and undertook programs to support the ow of credit in the economy.4 Specically, during two unscheduled meengs on March 3 and March 15, the Fed's monetary policymaking body, the Federal Open Market Committee (FOMC), voted to reduce the target range for the federal funds rate by a total of us percentage points, dropping it to near zero {Figure 5]. Moreover, the FOMC made it clear that it intended to keep that setting for a good whileuntil it could be confident that the economy had weathered recent events and was back on track for the Fed to achieve its dual mandate. Ta ken together, these interest rate Figure 1 Spending Plunged FRED . Personal Consumption Expenditures 10 Percent Change -15 Jan 2006 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 Jan 2016 Jan 2017 Jan 2018 Jan 2019 Jan 2020 Shading indicates U.S. recessions; the most recent one is ongoing. Source: U.S. Bureau of Economic Analysis fred.stlouisfed.org Consumer spending decreased 6.6 percent ($1 trillion) in March 2020 and 12.6 percent ($1.8 trillion) in April. NOTE: The data start in November 2007 to include the Great Recession. SOURCE: FRED*, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=r60z and https://fred.stlouisfed.org/graph/?g=r60v, accessed July 8, 2020. Figure 2 Unemployment Surged FRED . Unemployment Rate 15.0 12.5 10.0 Percent 7.5 2. 0.0 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 Jan 2016 Jan 2017 Jan 2018 Jan 2019 Jan 2020 Shading indicates U.S. recessions; the most recent one is ongoing Source: U.S. Bureau of Labor Statistics fred.stlouisfed.org The unemployment rate bounced from a low of 3.5 percent in February 2020 to a peak of 14.7 percent in April and 13.3 in May. NOTE: The data start in November 2007 to include the Great Recession. SOURCE: FRED , Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=15AM, accessed July 8, 2020.Figure 3 Employment Plummeted FRED - All Employees, Total Nonfarm 156,000 152,000 148,000 144,000 Thousands of Persons 40,000 136,000 132,000 126,000 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 Jan 2016 Jan 2017 Jan 2018 Jan 2019 Jan 2020 Shading indicates U.S. recessions; the most recent one is ongoing Source: U.S. Bureau of Labor Statistics fred.stlouisfed.org Total nonfarm payroll is a measure of employment. The measure peaked at 152,463,000 people employed in February 2020. By April, employment had dropped to 130,303,000. NOTE: The data start in November 2007 to include the Great Recession. SOURCE: FRED , Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=r5AQ, accessed July 8, 2020. actions helped keep borrowing costs low for households Figure 4 and businesses at a critical time. These actions will also Stresses Emerged Even in Some Treasury Markets help spur spending and investment when the economy Cents per $100 Billions of dollars emerges from the depths of the shock. 2.000 50 - First off-the-run (left scale) The Fed also took a number of steps to "unfreeze" key 1.800 1,600 financial markets. Such steps not only help these markets 40 1.400 run smoothly, they also encourage economic activity by 30 Cumulative Fed UST purchases_ 1.200 since March 1 (right scale) enabling the Fed's low policy rate to pass to other interest 1.000 20 800 rates and to affect financial conditions more broadly in 600 the economy. First, the Fed announced an enormous 10 Second off-the-run (left scale) 400 expansion of its purchases of securities, one that increased 200 On-the-run (left scale) its holdings by more than $2 trillion in the first two months of this policy (Figure 6). Such purchases keep markets Mar. Apr. May June 2020 working when assets are otherwise difficult to sell, inject cash into the economy, and also convey that the Fed NOTE: UST, U.S. Treasury securities. A bid-ask spread is the difference in the stands ready to "backstop" (reinforce) important parts price offered to sell versus buy a security; a widening spread indicates increased difficulty in finding a seller-buyer pair to agree on a trade. The red of the financial system. These purchases helped restore line shows that the most recently issued Treasury securities (referred to as more normal functioning of crucial markets, including 'on the run") traded smoothly during the initial weeks of the pandemic. In the market for Treasury securities, which, as Figure 4 high- contrast, the green and blue lines show that investors had trouble finding buyers of older Treasury securities (relative to the on-the-run security, the lights, was under significant stress.5 Second, the Fed first off-the-run security is the next youngest); the increase in these lines sig- lowered the cost banks face when borrowing directly naled a deterioration in market functioning. Then the green and blue lines declined-conditions in Treasury markets improved-as the Fed's securities from the Fed's discount window and encouraged them purchases, the black line, ramped up. to lean on this option, if needed, to help meet their SOURCE: Board of Governors of the Federal Reserve System (2020).Figure 5 The Fed Reduced Its Policy Rate to Near Zero FRED - Effective Federal Funds Rate Percent 2 2008-01 2009-01 2010-01 2011-01 2012-01 2013-01 2014-01 2015-01 2016-01 2017-01 2018-01 1019-01 2020-01 Shading indicates U.S. recessions; the most recent one is ongoing. Source: Federal Reserve Bank of New York fred.stlouisfed.org The federal funds rate is the Fed's policy rate; the effective federal funds rate is the volume-weighted median of the rates at which these funds transact in markets. The Fed uses its monetary policy tools to ensure the effective rate typically stays within the FOMC's target policy range. NOTE: The data start in November 2007 to include the Great Recession. SOURCE: FRED', Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=rbkO, accessed July 8, 2020. Figure 6 The Fed's Holdings of Securities Jumped Up FRED Assets: Securities Held Outright: U.S. Treasury Securities: All: Wednesday Level ssets: Securities Held Outright: Mortgage-Backed Securities: Wednesday Level Assets: Securities Held Outright: Federal Agency Debt Securities: All: Wednesday Level 7,000,000 6,000,000 5,000,000 4,000,000 Millions of U.S. Dollars 3,000,000 2,000,000 1,000,000 -1,000,000 2004 2006 2008 2010 2012 2014 2016 2018 2020 Shading indicates U.S. recessions; the most recent one is ongoing Source: Board of Governors of the Federal Reserve System (US) fred.stlouisfed.org SOURCE: FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/?g=r5Bn, accessed July 8, 2020.customers' demands for credit. The Fed also enlarged its offerings of \"swap lines" with foreign central banks to improve access to dollar liquidity around the globe.5 In addition, the Fed boosted its offerings of repurchase agreements {reposl with eligible nancial counterpar- ties; in this transaction, the Fed temporarily lends cash, taking as collateral a Treasury or other safe security. The use of the Fed's discount window, swap lines. and repo operations climbed in the early weeks of the shock and then retraced as nancial markets stabilized. To help provide credit to businesses, households, and communities where it was not othenivise available, the Fed also introduced several liquidity and lending facilities. The Fed is authorized to take these steps only in special circumstances and with specific approval? Overall, the Fed introduced 1 1 facilities to support various types of funding and credit marketsincluding markets for nan- cial instruments such as commercial paper, corporate bonds, municipal bonds, and asset-backed securities and businesses of all sizes.B With these facilities, the Fed aimed to keep key nancial markets and the flow of credit running in the economy. Some of these facilities began operating quite quickly, while others took more time to establish. By mid-June, a point before all of the facilities had become operational, these programs in total pro- vided about $150 billion in funds. In many cases, however, just knowing the Fed was providing a backstop source of liquidity or credit helped restore condence and activity in these markets. Conclusion Though the CO'v'ID-I 9 pandemic is primarily a health crisis, it has caused substantial disruptions to US. nan- cial markets and the economy. As a result, the Fed has responded forcefully. In the initial several weeks of the crisis, the Fed used interest rate policies to support the economy and took steps to stabilize nancial markets and restore the ow of credit to many sectors of the economy. Together with the scal actions of Congress and the administration, these steps have helped nan- cial markets resume more normal functioning and cre- ated conditions that will support an economic recovery when the public health crisis has sufficiently subsided. Of course, the path and timing of the recovery are subject to great uncertainty, and so, as noted by Chair Powell, "At the Fed, we will continue to use our tools to their fullest until the crisis has passed and the economic recovery is well under way\"? I econlowdown' click teach. engage. Article:" M 19 -Effects on Economy & FED (Federal Reserve System) Responds\"| 1.3ummarize the article. Focus on the important points, claims, and information. Discuss the main issues of the article. Express the main points, arguments, and ndings of the article in your own words. 2. Discuss the positive aspects of the article. Think about what the article does well, good points it makes and insightful observations. And most important how the article makes the point across What example, data and 9am examined- 3. Connect what you read in the article to your existing knowledge of the topic discussed in class GDP MM update the latest statistics. Do you agree with the article conclusion? Is the economy improving? 4. Write your critique. Use your outline of opinions to write 3 mm how well the article addressed the topic. Express your opinion about whether the article was a clear, thorough, and useful explanation of the subject