Over the weekend, the Federal Government took actions in an effort to stabilize our economy. Following is a brief Q&A summarizing and explaining the intent behind these actions in the wake of the coronavirus crisis.
Q: Why did the Federal Reserve lower the Fed funds target rate to zero?
A: The Federal Reserve lowered the fed funds rate—that’s the rate banks charge each other for loans—to zero in an effort to stimulate demand. This means lower interest rates on money you borrow, too. And lower interest rates will (at least in theory) mean that more people will buy things like houses, cars and other items. That means more money flowing through the economy again.
Q: What else did the Fed do to help us through this situation?
A: Several things:
- The Federal Reserve announced that it would be buying a minimum of $700 billion in bonds, including at least $500 billion in Treasuries and $200 billion in mortgage-backed securities. When the Fed buys bonds, it puts more cash into circulation.
- The discount rate (the interest rate that Federal Reserve banks charge depository institutions, or banks that hold deposit accounts like checking and savings accounts) was cut to 0.25%. This is significant for a few reasons, but mostly because there tends to be a stigma around using the Fed discount window—and they want that stigma gone so banks are more likely to use it. (Banks can borrow from the window for up to 90 days.)
- The Fed is encouraging banks to use its Intraday Credit—basically, credit that is for less than one day.
- The Fed has offered loan guidance, signaling that banks should use their liquidity and capital buffers to lend to households and businesses.
- The Fed has eliminated reserve requirements.
Q: What does the Fed hope to accomplish with these actions?
A: A few things:
- By cutting the fed funds rate to zero and announcing the purchase of bonds, the Federal Reserve is trying to make sure money continues to flow and our economy stays intact. Again, when the Fed buys bonds, the effect is to exchange a piece of paper—the bond—for cash. Adding more cash into the economy increases the supply of money.
- The second objective is to lower the cost of borrowing, which will provide short-term assistance to those affected directly by the economic disruption we’re experiencing to contain the virus.
- The final objective is to lay the groundwork for a demand-driven recovery once the crisis has abated.
That said, an important part of ushering the economy through this crisis is fiscal stimulus. That’s when the federal government decides to enact programs like payroll tax relief, paid time off, direct cash payments to individuals, business tax credits and other similar initiatives. The goal is to make up for the lack of consumer spending, which keeps the economy moving under “normal” conditions. When economic activity slows, tax receipts slow and the government must borrow to meet its needs. When healthy economic activity resumes, the fiscal stimulus is withdrawn over time.
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