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ABSTRACT
The policy responses of major central banks to the Covid-19 financial and economic crisis were faster, larger, and broader in scope than those in response to the 2008 global financial crisis. This article explains in detail the conventional and unconventional measures adopted by the U.S. Federal Reserve and reviews similar measures adopted by the Bank of England, the Bank of Canada, the European Central Bank and the Bank of Japan. Apart from lowering interest rates and acting as lenders of last resort to financial institutions, these central banks embraced large scale asset purchases as a core crisis fighting tool, with the corresponding expansion in balance sheet that they entail. The article connects this change in emphasis in central bank intervention to the normalization of shadow banking, or market-based financial intermediation, that happened between the two crises. Other extensions of the role of central banks made possible by the scope of the policy responses to Covid-19, including direct support to sectors beyond the financial industry, are also explored.
Acknowledgements
I would like to thank the participants of the conference The Future of Central Banking, Talloires (France), May 26–28, 2019, where preliminary ideas for this article were presented, as well as Ian Buckley, Jo Michell and an anonymous referee for comments and suggestions.
Disclosure Statement
No potential conflict of interest was reported by the author(s).
Notes
1 Source: U.S. Employment and Training Administration, Continued Claims (Insured Unemployment) [CCSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CCSA, August 24, 2020.
3 Throughout the text, I use $ to denote U.S. dollars and ISO 4217 three-letter codes for other currencies.
4 See, for example, https://www.nytimes.com/2020/04/02/opinion/coronavirus-economy-stimulus.html
5 As a response to persistent low inflation and slow growth in the years following the 2008–09 crisis, several central banks began experimenting with negative interest rates policy (NIRP) in 2014-15, including the ECB, the Bank of Japan, and the central banks of Sweden, Denmark, Bulgaria and Switzerland. According to the comprehensive review presented in Jobst and Lin (Citation2016), these rate cuts worked as expected, in the sense that they led to lower lending rates across the economy and a corresponding easing of credit conditions. Unsurprisingly, the overall effects of NIRP were modest, given that the policy rates were reduced to only modestly negative values in the range of -0.25 to -0.75%, whereas to stimulate a depressed economy they would need to be lowered much further, possibly in the range of -1 to -2% (see Grasselli and Lipton Citation2019b for a full discussion). Because this is lower than the so-called ‘physical lower bound’, namely the rate at which, taking into account storage costs, it becomes more advantageous to withdraw cash than to keep bank deposits, it is improbable that such rates will be ever implemented, unless cash itself is replaced by central bank digital currencies (CBDC). In view of that, NIRP are likely to remain confined to a footnote in monetary policy.
6 Discovered almost by accident in 1922 (see https://www.minneapolisfed.org/article/1988/discovering-open-market-operations), open market operations turned out to be a very effective way to conduct monetary policy in normal times, that is, outside of crisis periods. In the course of their daily operations, banks use reserves (essentially deposit accounts at the Fed) to settle payments between their clients. Banks with reserves in excess of the required amount have an incentive to lend them to banks that need them in order to fulfill their reserve requirements. The average interest rate prevailing for this type of interbank lending is called the Effective Fed Funds Rate. Whenever the effective rate is above the policy rate, the Fed purchases government securities from banks in exchange of reserves, thereby increasing the total amount of reserves in the banking system and bringing the effective rate down. Conversely, whenever the effective rate falls below the policy rate, the Fed sells government securities, thereby draining reserves from the banking system and brining the effective rate back up to the level of the policy rate. Absence of arbitrage in these market guarantees that the yield on short-term government securities remains close to the Effective Fed Funds Rate, and consequently to the Fed policy rate. As we will see, market disruptions can lead these rates to diverge from each another.
7 The 2008 TALF specified that ‘All U.S. persons that own eligible collateral’ could borrow from the facility, whereas in the 2020 version this has been restricted to ‘All U.S. companies that own eligible collateral and maintain an account relationship with a primary dealer’, presumably for operational expedience. On the other hand, eligible collateral for TALF loans has been expanded from asset-backed securities based on ‘auto loans, student loans, credit card loans, or small business loans guaranteed by the U.S. Small Business Administration’ in the 2008 version to much larger set of credit exposures in 2020. By contrast, Primary, Secondary, and Seasonal credit facilities are restricted to depository institutions and require government securities as collateral.
8 The full list of additional countries with their corresponding maximum amounts is: the Reserve Bank of Australia Banco Central do Brasil, Bank of Korea, Banco de Mexico ($60 billion), Monetary Authority of Singapore, and the Sveriges Riksbank at $60 billion each; the Danmarks Nationalbank, Norges Bank ($30 billion), and Reserve Bank of New Zealand at $30 billion each.
9 Maiden Lane is the name of the street on the north side of the Federal Reserve Bank of New York (FRBNY) headquarters in Manhattan, where the details of the deal with JPMorgan Chase were being discussed during the frantic weekend of March 15-16, 2008. The acronym LLC means a limited liability corporation and, in this context, indicates that the facility was established as a special purpose vehicle (SPV), that is, a separate legal entity with a specific mandate. Specifically, the FRBNY and JPMorgan made loans of approximately $29 billion and $1 billion, respectively, to this SPV, which in turn used the loan to purchase the assets from Bear Stearns and managed them until they were sold over the next several years and the loan was fully repaid with interest. The use of SPV became a staple of unconventional measures by the Fed and also made a comeback in 2020.
10 Namely the Main Street New Loan Facility (MSNLF), the Main Street Priority Loan Facility (MSPLF), the Main Street Expanded Loan Facility (MSELF), the Non-profit Organization New Loan Facility (NONLF) and the Non-profit Organization Expanded Loan Facility (NOELF).
11 The pace of purchases announced in each round were as follows. November 25, 2008: up to $100 billion in housing-related GSE (government-sponsored enterprises) debt and up to $500 billion in MBS, extended on March 18, 2009 to $100 more in GSE debt, $750 billion more in MBS, and $300 billion in long-term Treasury securities. November 3, 2010: further $600 billion in long-term Treasury securities. September 13, 2012: additional $85 billion per month in MBS and long-term Treasury securities.
13 Repurchase agreements (repos) operations conducted in support of monetary policy increased from pre-crisis limits of about $100 billion in overnight transactions to more $500 billion – essentially providing unlimited liquidity to primary dealers in the Fed funds market. For current and historical limits and other details of repo agreements see https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements/repurchase-agreement-operational-details
14 See https://www.bankofengland.co.uk/markets/bank-of-england-market-operations-guide/results-and-usage-data for updated values.
16 See https://www.bankofengland.co.uk/-/media/boe/files/speech/2009/the-bank-of-englands-balance-sheet
19 See this blog post by the ECB President Christine Lagarde released the day after the announcement of the program: https://www.ecb.europa.eu/press/blog/date/2020/html/ecb.blog200319~11f421e25e.en.html.
20 See the speech by the ECB Chief Economist Philip R. Lane: https://www.ecb.europa.eu/press/key/date/2020/html/ecb.sp200624~d102335222.en.html.
21 The Eurosystem consists of the ECB plus the National Central Banks of member states. For the consolidate balance sheet, claims between participants of the system are netted out. Weekly consolidated financial statements are available at https://www.ecb.europa.eu/press/pr/wfs/html/index.en.html.
22 See https://www.boj.or.jp/en/statistics/boj/other/acmai/index.htm/ for details.
24 The term ‘shadow banking’ was coined in 2007 by PIMCO economist Paul McCulley in a speech at the Fed’s annual symposium in Jackson Hole. McCulley had also coined the term ‘Minsky moment’ in 1998 to describe the Asian debt crisis of 1997, and has played an important role in bringing the work of Hyman Minsky to the attention of investors, mainstream economists, and policy makers since then. See https://www.iosco.org/library/annual_conferences/pdf/ac34-5.pdf
25 See https://www.fsb.org/2020/01/global-monitoring-report-on-non-bank-financial-intermediation-2019/
26 See https://www.bis.org/publ/bcbs188.pdf for liquidity rules in Basel III and https://ec.europa.eu/taxation_customs/taxation-financial-sector_en for the FTT proposed by the European Commission.
27 For example, see https://web.archive.org/web/20100530081636/http://www.economist.com/business-finance/displaystory.cfm?story_id=16231434
28 See https://www.fsb.org/wp-content/uploads/IMFC-Statement-April-2015-FSB-Chairman-Mark-Carney.pdf
29 A so-called ‘wealth channel’, whereby a lower interest rate leads to a higher valuation of discounted future cash-flows and consequently higher asset prices, has always been considered a possible transmission mechanism for interest-rate policy. Large scale asset purchases, by directly putting a floor on the prices of entire classes of assets, appears to be a much stronger channel.
30 See https://foreignpolicy.com/2020/05/13/european-central-bank-myth-monetary-policy-german-court-ruling/
34 See, for example, https://www.ft.com/content/f128ffd8-1d28-4f9b-b3aa-4b798ebdae3e.
36 Technically called Bank of Canada deposits. See https://www.bankofcanada.ca/rates/banking-and-financial-statistics/chartered-bank-selected-assets-monthly-average-formerly-c1/ for updated data.